I wasn’t surprised by the headline I saw in the Guardian last week: “Born after 1960? Then you’re probably poorer than your parents”.
I mean, in an indirect way it’s been a theme of The Right Side down the years. But why was it in the news? Well, that was the outcome of a report published by the Institute for Fiscal Studies (IFS) this week.
What really is shocking is the fantastic speed with which the inter-generational fortunes have swung around. And it really all comes down to just five things. Five factors have served to whip the rug out from under the feet of many in my generation.
For many, it won’t be particularly happy reading. But it’s worth being realistic at least.
How things went wrong
1. Private sector pensions got blasted
When I joined the workplace in the late ’90s, a decent pension scheme was still on the cards. That is, a defined benefit pension scheme: one in which the firm pays you some percentage of your final salary, right up until it’s time to shed the mortal coil.
But already in the late ’90s, many businesses were beginning to realise that these commitments were unaffordable. Gordon Brown’s assault on the defined benefit pensions industry shouldn’t be underestimated either. The lifeblood of these ‘funded’ schemes is the income they receive on their investments. Brown took away pension dividends’ tax free status. That was a hammer blow to the industry.
The millennium stock-market crash saw off most of the schemes that were still alive, but struggling.
A pension system that had evolved for decades was dismantled in a few years. Of course, anyone who had accrued benefits in these schemes was still entitled to them. But the doors were shut to the next generation.
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2. Rates slashed
Not everyone who’d retired was lucky enough to be part of a defined benefit scheme. There were plenty of defined contribution pension schemes too. In those type of schemes, you don’t know what benefit you’ll get until you actually retire.
At that point, the fund is cashed up, you receive a lump sum (tax free) and then buy an annuity with the remainder of your fund. An annuity is effectively an insurance policy that pays you an income for life.
Back in the early ’90s, these policies were paying out something like £15,000 for every £100,000 in the pension pot. The stock markets had had a pretty good run, so for many, an income of say £30,000 was within reach.
Not only did they secure a good income for life, but it turned out that lives were getting longer and longer.
Because of longevity and low interest rates, annuity policies have been getting steadily worse. Today, if you want to secure an annuity income of £30,000 (index linked), you’ll need to have saved a pension pot of £1m. That’s not within easy reach for most people.
3. Pay restraint
Globalisation – the knitting together of distant parts of the world economy – and new technologies have definitely brought some improvements. But they’ve also had the effect of keeping wages in check. The IFS report found that between 1974 and 2002, households saw real earnings (that is, taking inflation into account) grow by an annual average of 1.5%. But since 2002, they’ve only grown by a paltry 0.1% a year.
So just at the point when people need to save more, they’ve stopped earning more money.
4. Housing costs
Their house is most middle class families’ biggest asset. And the property market has held up well – which has been a great benefit to the already-retireds. But those in the younger generations have to spend more and more money on housing.
The amount of wealth sucked into the property market is truly astounding. And it doesn’t take much imagination to see how things could go horribly wrong from here.
As we’ve just seen, for a generation that’s already had the stuffing kicked out of it by way of wage restraint and pension scares, the last thing it needed to do was to over-borrow for housing.
But that’s what’s happened. If and when interest rates go back to their normal levels, expect extreme pain for those overexposed to property. As rates rise, of course, they may be able to look forward to slightly better annuity rates, but I don’t think that’s going to come as much comfort.
The IFS report concludes that the coming generation of retirees will be pinning its hopes on a decent inheritance. And for many that will be true. But was we know, the already-retireds are living much longer than the generation before them. It can be a long wait. And anyway, all this living costs money. Especially if it involves a care home.
It is now expected that family wealth (even if it’s tied up in property) should be used to finance care of the elderly. And that’s fair enough. But it may not leave much (if anything) in the pot for future generations.
So there you have it: five pretty much unavoidable forces at work which are stultifying real wealth in retirement.
Unavoidable? Yes, of course they are. You cannot have a society living longer, and not expect to have to pay for it. I guess we should all just be realistic. What is required is a diligent savings culture alongside the acceptance of working longer.
What most certainly is not required is punting all the wealth on a property bubble. That’s not real wealth. It’s not sustainable.