How would you cope if the government took your pension away?
One of the scariest stories that you might have come across in newspapers over the last few years concerns the extraordinary national pension deficit that’s currently affecting Britain, as well as many other developed nations. This was highlighted in an expose by The Financial Times, which indicated that of all the pension schemes currently in the UK, 84% are in deficit. In Britain alone, it’s estimated that the shortfall between what the government has in reserves for paying the state pension, and what it needs for the future, is a massive £400 Billion difference. Yes, you read that right – £400 BILLION!
The cause of this deficit is simple. People are living longer, so they require a state pension for longer. The fix is anything but simple though. If the government owns up to the problem and declares an end to the state pension system, there will likely be riots on the streets, and they will lose any hope of re-election. If they try to raise taxes to make up for the shortfall, then the same things will probably happen. All I can say is I’m glad I’m not a politician right now.
The future of your pension is as uncertain as it’s ever been
The likely scenarios for the future of state pensions are:
- Retirees agree to take a cut to their state pension and receive less than they were originally promised.
- The government and corporations borrow more to cover the pension shortfall, pushing up national debt levels.
- Interest rates rise, making investing return targets more manageable. That’s great for investors, not so great for anyone with a mortgage.
- The schemes simply collapse in on themselves under the weight of their own deficit.
But how has this problem come about? You can blame successive governments if you like, but the real culprits are the central banks and their insistence on loose monetary policy over the last decade.
When you pay money into a pension, the pension provider invests it and tries to grow it to a sizeable enough amount that it will cover the period of your life when you’re not working. Usually, these providers prefer to invest in big, stable, long-term investments such as government debt, or Gilts as they’re known in the UK.
Unfortunately for us, the yield on Gilts has collapsed since the financial crisis in 2008 and 2012, which has meant corporate investors have flooded other markets with money in a search for alternative high yields. This, in turn, has further crushed the expected return on Gilt investments to levels not seen for several decades.
Compounding the effects of the low yields on government debt are the central banks continual cutting of interest rates which has made it extremely difficult to find alternative products that offer decent, low-risk returns.
Longer lives mean more money is needed in your retirement
And in addition to low yields and interest rates, the way some pension schemes are structured are leaving the rest of us with an uncertain future too. Defined benefits pensions are now almost extinct for new entrants, and those people who are lucky enough to have them are in no hurry to change products anytime soon. The reason for this is that defined benefit schemes promise to pay out a fixed pension sum regularly, no matter what the rest of the economy is doing.
Unfortunately (or fortunately, depending on how you look at it), increased life spans mean that pension providers have to keep making these fixed payments for longer and longer. Alarmingly, out of 6000 defined benefits schemes in the UK, there are currently 5000 in deficit. In fact, the current estimation of how much providers of defined benefits schemes would have to pay out if they honored everything as promised, verges on an eye-watering £935 Billion. The ultimate effect is that the pension provider money pots are paying out more and more as additional people retire, but the returns from the invested money that goes in is getting smaller and smaller.
There’s some relief to be had from the Pension Protection Fund in the UK, which is a lifeboat that provides reduced pension payouts to retirees whose pension schemes have folded under the pressure of increasing deficits. If a pension scheme collapses, then the PPF will pay yet-to-retire members 90% of what they were originally promised, but depending on financial circumstances, some retirees will get much less. Ultimately, the money held by the PPF is finite, and it will eventually run out, potentially leaving millions of pensioners with collapsed private pensions schemes and a state pension that could be withdrawn at any time.
You cannot rely on the government to look after you
So what can we take from all this? Well, the future looks bleak for anyone who is solely relying on the government to look after them in old age, and even those who have public funded pension schemes are likely to feel the pain in years to come. But for those of us with a little bit of financial knowledge, the future looks rosier, if not completely smelling of roses. Using UK tax efficient wrappers such as ISAs and SIPPs, allied to some well-considered investments in the stock market, private investors can take fate into their own hands, and build an inflation beating retirement fund that will last them throughout their later years. The moral of the story is, if you want a wealthy future, you’re going to have to make it happen yourself.
Facts and figures: Population projections
- The number of people aged 60 or over is expected to pass the 20 million mark by 2030.
- The number of people aged 65+ is projected to rise by over 40 per cent in the next 17 years to over 16 million.
- By 2040, nearly one in four people in the UK will be aged 65 or over.
- The percentage of the total population who are over 60 is predicted to rise from 24.2% at present to over 29% in 2035.
- The number of people over 85 in the UK is predicted to more than double in the next 23 years to over 3.4 million.
- The population over 75 is projected to double in the next 30 years.
- Nearly one in five people currently in the UK will live to see their 100th birthday. This includes 29% of people born in 2011.