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The hard facts on retirement

The combination of the 20 per cent dividend tax on pension funds, falling returns, new accounting standards and the employer&#39s open-ended commitment to make up whatever shortfall the actuary deems to exist means we have a pension system with no future. Reduced National Insurance rebates add to the lethal cocktail of legislative and market conditions. It seems our legislators actually want to see the end of defined-benefit schemes.

Such schemes may become the exclusive preserve of the public sector. But imagine the public outcry if everyone apart from civil servants had to make do with inferior defined-contribution schemes?

Strangely enough, I feel we should welcome this trend. The cost of running DB schemes is very high. They keep actuaries and fund managers employed but do not necessarily deliver the investment performance to save the employer from the consequences of poor performance.

At the same time as profits are turning into losses, the actuary may provide the unwelcome news that the company needs to make up the pension fund shortfall. This adversely affects solvency at a time when it can be least afforded, aggravating the effect of the business cycle. The employee might find themselves with neither job nor pension rights.

The numerous public sector DB schemes now have serious shortfalls which will be funded by a rise in taxes, so the public may pay twice over.

The administration cost is likely to be well over the 1 per cent a year of stakeholder pensions. The 1 per cent may be just profitable on a big group pension basis once critical financial mass has been achieved and 10 years elapsed.

The fundamentals are common to both DB and DC schemes. The employee and employer contributions are invested in a range of managed investments as a long-term savings plan to provide retirement income. The DB and DC schemes have the same objectives and investment requirements to achieve the same end.

If, however, group stakeholders are cheaper to run, then more money is available for the investments which deliver the eventual goods. The sheer complexity of DB schemes creates costs and problems when members leave and there is no correlation between benefits and the sum paid.

Under a DC regime, the pension misselling debacle could not have occurred. The problem was caused largely by inadequate transfer values from ceding schemes which saved immeasurably when members left. The Treasury saved billions of pounds.

Consider a high flyer initially enjoying rapid promotion who steadily sees income fail to keep up with the average, perhaps due to poor health. His pension will be prejudiced at retirement as it is based on the average of the last few working years.

Consider by contrast the fortunate person whose career takes off later with directorships and high earnings. His pension benefit could be out of all proportion to what has been paid in.

So, all in all, our present favourite but vanishing DB schemes have many anach-cronistic features.

Yet the Government still wants to reduce its cost of funding retirement. At present, the burden is two-thirds state and one-third private sector. This is good by continental European standards but the Government wants private provision at two-thirds. But it is comfortably on track to achieve a bigger than ever proportion falling upon the state.

DB schemes are vanishing and replacement DC schemes are receiving only about half as much in contributions. However, DC schemes may be far cheaper to administer. They also offer the opportunity of individual choice of funds, investment management strategies and contracting out.

Some experts have calculated that to fully fund savings for retirement adequately, the nation needs to save £27bn more every year. I cannot challenge the actuarial calculations behind this but it is interesting to note that this figure is similar to the UK balance of payments deficit. We import about £27bn every year. This is partly made up by earnings on invisibles but as a nation we are importing far too much. The reason we do not have a crisis is that plenty of foreigners have been happy to buy our electricity and water supply companies and railways. As long as this carries on then, we can continue to import more but one day we may have to get real.

The lesson in this is that if we compulsorily had to save this money into our pensions every year, we could kill two birds with one stone. The snag is it could precipitate a slump, causing unemployment and increasing the need for state benefits.

Excessive mortgage costs created by crazy increases in house prices, due to the failures to release the necessary land for building and the failure of our transport system to move people at economic cost, would have a frightening impact if a rise in unemployment accompanied a big switch into investment from spending.

Pension provision is made even more difficult by remarkable longevity coupled to declining birth rates in the last 20 years and is likely to get worse. Add the reduction in investment returns taking place over the last few years compared with, say, the 1980s and we have a quintuple whammy.

Why not make pension contributions compulsory? Such action would precipitate a massive slump, as profits and investments returns fell and companies paying contributions found they could not compete thanks to £30bn of extra costs heaped on the industry by six years under the Government of Blair, Brown and Campbell.

Looking further at this savings gap argument, if we increased the savings for retirement by £1,000 per head of population, where would we put that money? It must be invested but returns are falling. Companies such as Ford and General Motors and have all but closed down in the UK, claiming they cannot make profits from making cars and trucks, yet GM is now busy lending money out for mortgages on houses at 4 per cent a year.

General Electric has closed down all UK lighting manufacture is happy to go into financial services, buying National Mutual Life from its members.

In the new world order, China will supply all the cheap goods we want at prices which we cannot compete with. The world excess of industrial capacity, thanks to massive investment in factories situated where national interest rates were historically always low, encouraged investment in highly capital-intensive industries in countries with low interest rates. This means that the returns on investments and, indeed, opportunities for profitable provision of new UK capital-intensive manufacturing capacity have been severely eroded. Hence, the lack of investment opportunities in the UK.

Investment returns will fall even further if more money is available for investment without the corresponding opportunities to absorb all that investment. Foreign ownership of so much of our industry and now services as well reduce the available opportunities for direct investment. The problem is aggravated by the very open nature of the UK economy, which is not reciprocated elsewhere in Europe.

An obsessive combination in the UK of tight monetary policy with a lack of fiscal rectitude for 40 years in the belief that the economy should be controlled by maintaining interest rates higher than elsewhere while cutting public sector investment and keeping down consumer taxes for electoral reasons has created a regime where businesses had to earn a higher-than-average return on capital just to survive. It has resulted in lack of investment in high capital-intensive industries.

We smugly brag to the rest of Europe that the liability of state pension provision is far lower here. However, it has been at a price borne by the private sector. Indeed, the total sum of non-state pension funds is a figure about equal to our annual GDP.

There has been a price which was not obvious. We have the biggest stockmarket capitalisation in Europe. Profits as a return on capital have been higher than the European average. They had to be, if any investment was to be internationally competitive. But because our investments have been so heavily used to fund pension income, UK companies have been under undue pressure to maintain high dividends. Thus, we have lost investment potential in the UK in high-value industries which can increase overall national wealth. For this reason, we actually now lack investment opportunities in the UK to absorb this extra money that the Chancellor and ABI want us to save.

We could make investments abroad into capital-hungry areas, such as the Far East, Eastern Europe and Russia. But how many people will wish to see their hard-earned savings for retirement invested in areas of the world which are deemed high risk and where the best investment opportunities tend to be reserved for local investors and the worst ones open to outsiders?

In the 1 per cent world, I do not see much scope to pay for investment fund managers in these regions.

Having demonstrated the need for joined-up Government, we need to know where to go from here.

We must start from the premise that it may not be possible to save to provide retirement income at an adequate level for everyone. If we are living five more years than 15 years ago, we must be economically productive for five more years. It is unrealistic to expect the hard-pressed young members of society to subsidise the older generation&#39s overblown expectations of affluence in retirement.

The cost to the young of providing for education, university, private healthcare and housing is throwing an unfair burden on them, discouraging them from having children and creating a vicious circle.

To correct this, the old will have to continue working, unless they are too ill. Ageism will have to be as politically incorrect as racial discrimination or sexism.

There must be no compulsory retirement age. As the population falls, so economic forces will increase the demand for older workers. If the population is kept busy as they get older and still earn enough to maintain a good lifestyle, they will remain healthier and live longer.

I started by pointing out the obvious. DB schemes are going and DC schemes may be a poor substitute. But unless we can find a home for investments, maybe the state will have to provide out of taxation and use public-sector investment opportunities to provide a pension fund safe haven.

Enforced investment into higher pension provision is almost certainly is a nonsense. Politicians should recognise that the world has changed a lot. Of course, no election will be won on a platform of lower benefits for pensioners and late retirement unless the hard facts about the demographics are presented to the population.

People want to retire at 65 or earlier given the chance but generally it will not happen. Let us get Tony Blair&#39s spin doctors to do something useful and tell the public the reality of the situation. It is a time for a national debate.


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