Do pension policies get more short-termist than this?

Lottery-winning pensioners © Getty Images
Pensions policy: like winning the lottery

Some readers think that my recent remarks on stockmarket falls have been flippant.

And it’s true, I’m kind of sanguine about the markets. My take is “where else are you going to put your money?”

I’m not going to deny it – this is proper ‘hold your nose, and put your money down’ investing.

But we are living in a world of artificial markets, where we have to ride the ride or get left behind. Self-preservation forces us to invest in markets we know are fundamentally flawed. Face it – there are precious few alternatives.

In this sort of climate, it’s no surprise that people are starting to look for the quick fix.

Some are even getting creative with their pensions; and if you’re saving into one, or you’re already drawing it, this is something you might want to hear.

Giving up the Holy Grail

Savers haven’t hung about getting their teeth into George Osborne’s new pension reforms.

Now that we’re going to be allowed to withdraw as much of our pot as we damn well please, people are starting to dream up ways to get their hands on their cash.

Even, it appears, many of those fortunate enough to be on defined benefit (DB) schemes!

These are the so-called ‘gold-plated’ pensions generally paying out an inflation-linked percentage of your wage until death.

And a study by actuaries at Hymans Robertson suggests that up to 30% of retirees on gold-plated schemes will actually want to convert their savings to a standard private pension.

These things are supposed to be the holy grail of pensions. Why would anyone want to switch?

They want the money

It all comes down to the rules.

The thing is, if you have a DB pension, you can’t get your hands on it early. Only with defined contribution (DC) schemes can you plunder your pot for as much as you want (subject to tax, of course!).

So anyone on a DB scheme who wants to get their mitts on a lump sum has to first convert it to DC.

To do this, they need their DB scheme’s actuary to figure out what the scheme is worth in cold hard cash – this is known as a ‘transfer-out valuation’.

With that done, this person is free to transfer the money into a private scheme, where he or she can do with it as they will.

So what’s the problem there?

You’d be mad to give up a gold-plated pension

I’m reminded of the pension debacle of the 1980s.

Many workers with very good company schemes were duped into moving their cash into private schemes administered by highfalutin financial bods.

Needless to say, the salesmen didn’t focus on the fact that the risk now moved from the employer to the individual. The financiers did well; the poor old suckers were left holding the can when the 1987 crash erupted!

So to those considering switching, I’d say: frankly, beware! There are no investments at all out there offering the sorts of returns available from a defined benefit scheme.

These are, after all, promises made by governmental bodies, or large companies, offering not just a decent income, but guaranteed growth, too.

Given this generosity and the dearth of investments available to fund such schemes, there’s no doubt that if you want to put a value on these DB promises, then it’s going to be a very high one.

We’re talking about a transfer value (ie, the value that the actuaries place on the pension to work out how much money you can cash out) that could be in the millions!

It may be giving up a pretty much irreplaceable source of guaranteed and growing income, but now you see why some retirees will want to get their hands on the money up front.

Imagine the council worker who cashes out part of his or her pension for a million quid. It’d be like winning the lottery!

Obviously, there’s a big risk

The new private pension reforms will allow holders certain flexibility in getting their hands on their pension savings. As one critical MP noted: “they can go out and buy a Lamborghini if they so choose!”

The general principle is that you can get 25% of the pot tax-free on retirement and then pay your marginal rate of the tax as you take the rest.

The government’s response to criticism goes along these lines: “Well, these guys were prudent enough to make the savings, we should trust them to be prudent in drawing down the savings too.”

But should we be equally trusting of those transferring DB schemes to DC ones? 

Many of these guys have never been involved in investing before. They haven’t quaked at a pension statement during times of financial turmoil. They haven’t suffered sleepless nights considering exactly how much to shell out each month on pension savings to keep them from penury in later life.

And frankly, many have no experience in the decision-making process of how to invest pension savings.

If that’s the case, then why has it been allowed?

Well, I’ve got an idea. There could just be one vested interest group set to profit from the new scheme.

A cynical ploy?

When I first considered the proposition that state workers would be able to ask for an actuarial valuation of their pension, and then transfer to a private pension, I assumed it would cause the Treasury a considerable cash-flow problem.

But on further inspection, I’m not so sure.

Consider this: releasing money that has hitherto been tied up in pension savings will undoubtedly be positive for the economy.

Say the government writes a cheque for £1m and the lucky recipient sticks it in his Sipp. Let’s say he wants to live the high life for a while – new car, fancy holiday, dream kitchen, you get the idea.

The government reaps rewards all the way. From the income tax on the drawdown (could see them take 20% or 40% straight back!), then there’s VAT (20% remember) on all his spending. Not to mention the knock-on taxes collected through the businesses supplying the guy with all his newfound luxuries. And there could be a lot of lottery winners out there!

So there’s no doubt that pillaging tomorrow’s savings will give the economy/state coffers a boost. And if the government revenues are still in shortfall – no problem. They simply sell some gilts (bonds issued by the UK government) to balance the books.

What a wonderful spin on quantitative easing (QE). Previous QE missions have filled bank coffers with cash. This type of QE will be much more effective at releasing cash into the real economy.

And as for the members of corporate schemes, well, there’s no cost to the government whatsoever. The corporations will be only too happy to let the members go it alone (reducing their own pension liabilities in the process, of course). And if the members want to spend the cash, then the government will pick up all the associated taxation benefits!

Allowing migration from defined benefit schemes to defined contribution (and thus early drawdown) is about as short-termist a policy as is the policy of loading the nation up with debt.

But hey – let the good times roll!