if we don’t educate the young then the problem gets worse and the ‘car crash’ becomes a pile up.
The UK pension system (both private and state) has been in decline for many years and little has been done to reverse this. In recent years there have been calls to overhaul the system and the latest government changes are welcomed, but the press headlines less so.
In this blog we touch on two things – the decline (and fall) in pensions and the brave new world.
The decline and fall of pensions
In 1951, life expectancy was 66 for men and 70 for women, by 2011 it was 78 for men and 82 for women. By 2014 according to data from worldbank.org, male life expectancy had increased to age 80 and for women, 84. It is not inconceivable for people to live into their nineties and beyond in the next few years.
Despite this change in demographics there has been no real change in individual’s expectations of retiring at 65 for men and 60 for women. (Even though from 2010 the state scheme started the process of equalising the retirement ages for men and women).
In the UK the golden generation, as they are now referred to, enjoyed guaranteed pensions in retirement. They worked all their lives then when they retired not only did their company pension scheme give them a guaranteed pension, for life, but also the state pension topped this up.
Annuities are based on a number of different factors but life expectancy is a crucial one. As people live longer it means that the cost of providing that income is more expensive and companies simply cannot afford that cost. As a result we saw most guaranteed pension schemes closed. Only the public sector schemes remain open, with a smattering of private schemes.
The challenge for these public sector schemes is that on the current scheme retirement age the government simply cannot afford to fund them. Public sector schemes have a choice; close, significantly increase contributions or raise the retirement age further. These moves will not be popular because people see their retirement age as a right.
For those not so fortunate, fortunes are wrapped up in their pension fund. The challenge is that 15 to 20 years ago the annuity (pension) you could buy was significantly higher than it is now. Individuals claim this is unfair but forget that the sands have shifted so much that the money has to last longer and therefore any income being offered will be less.
Where we are today is the ‘car crash’ which was waiting to happen, has happened. The challenge for the younger generation is what to do.
Cruise, Ferrari or Pension
Before considering the younger generation it is worth considering the headlines – pension freedom unlocks pension money for millions to spend as they wish…..
These headlines are dangerous because it takes away a fundamental aspect of saving, which is having a plan and delivering on that.
If someone is convinced that they wish to cash in their pension fund (or sell their annuity), then it may be worth talking them through some questions and answers:
- Question 1: What was the purpose of the pension fund? It is likely that it was to provide an income in retirement
- Question 2: Would not having that income make a difference to your retirement? Yes – likely to have to return to work
- Question 3: Have you considered the tax implications of taking out all your pension money? In many cases although there is tax free cash the balance will be taxed at 40%
- Question 4: What are your plans with the money? Can they get a better income, or are they looking to spend it
The point of the questions is help people focus on the consequences of their actions.
Using the new flexibility in pension rules in the right way can enhance someone’s financial planning in retirement – for example, it can be used to pass on wealth in a tax-efficient way, it can be used to fund care costs etc. But misleading headlines open the opportunity for disappointment.
It seemed almost palatable to start working at 20 and then retire at 65. Perhaps there was some hope that we could retire at 55. For some this dream can happen, but for many it won’t.
Other factors need to be considered – the retirement age of 65 was set when most were lucky to live for 5 years in retirement. By the time a twenty year old today gets to 65 they could enjoy 25 years plus in retirement.
The importance of financial plans is possibly more relevant today than ever before. In a recent interview an American Financial Planner said “What good is planning for the future if you can’t enjoy today? But what good is living for today if you have no plan for the future?”
Thinking about their financial future is an important lesson for young people to learn. We must ask simple questions about what they want to achieve in the future, what they plan to do etc, to focus their minds on their goals. Once they have their goals they can look at how to achieve them. We focus so much on the products (the pension, ISA etc) but those are only the means to deliver the goals as is the investment strategy.
If you can’t identify the goals then everything else is irrelevant.
And strangely when we get to this point we realise that the questions we ask when someone wants to cash in their pension leads back to the twenty year old we are talking about today. If they have no plan, when they get to 65 or 70 and want to cash in their pension they will have wasted 45 or 50 years of financial planning.
And so we conclude
What no-one is prepared to say is that our pension system (both private and state) has been in terminal decline for years due to changing demographics, poor education and a lack of drive to change anything. Only because of the global financial meltdown were governments forced to act, but education remains inadequate.
Changes to our pensions rules highlight how having greater flexibility with the pension fund is important but this only works if you go back to your plan. If you have no plan then you are in danger of making irrational and life changing decisions. Hopefully most people are rational and the fear of what might happen, won’t. However, if we don’t educate the young then the problem gets worse and the ‘car crash’ becomes a pile up.
This is not about trying to spread fear, these are the cold hard facts of what we are facing today.
The lesson is real and education is paramount if we are to guide the next generation through a financial minefield.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.