David Pitt Watson FRSA reports on an RSA project aiming to change people’s pension options and asks for Fellows’ help in doing so
The population of the UK is getting older: if we do not start saving more, many people will face insecurity and poverty in their later years. While these facts are well rehearsed, many of us do not save for old age and mistrust the pensions market, a problem exacerbated by the financial crisis and many seeing their savings diminish.
It was to respond to these issues that the RSA developed the Tomorrow’s Investor project two years ago: its focus was to look at what kind of investors we need to become if we are to secure a more stable and independent future. Our latest research suggests that huge benefit could be gained if we were to create a better framework for the provision of pensions in this country. As the latest report states: “If a typical British and a typical Dutch person save the same amount of money for their pension, the Dutch person will receive up to 50 per cent more income in retirement than the Briton”.
This happens not just, or even primarily, because the pensions industry offers overpriced products. If British pensioners are to enjoy the benefits accorded to those on the other side of the North Sea, it will require a change in the way we design the institutions which provide pensions in the UK.
A generation ago Britain had a system of occupational pension provision which was dominated by large, collective pensions. Each pension fund received a contribution from the employer, and from the employee, and, over time, the employer guaranteed that this would provide a certain level of pension. These were known as defined benefit pension schemes.
However, the past decades has seen defined benefit schemes dismantled piece by piece. Today pensions in the private sector are provided in smaller, individual accounts, with no employer guarantee. But in making this change, we overlooked other aspects of pension ‘architecture’; from the large collective schemes which characterised defined benefit, to individual accounts which characterise defined contributions.
First, we overlooked the importance of costs. Costs matter a lot because they compound over time. What many fail to realise is that a 1 per cent per year charge will take about 25 per cent off the value of the pension. And large pension funds have lower costs.
Second, we failed to note that collective pensions are very different from individual ones, in part because they have lower costs. But also because their investment philosophy will be different. As they reach retirement, the person who saves individually will need to be very conservative, ideally buying a very safe, but very costly annuity which will guarantee their income. The person who saves collectively can take a higher risk because they take it with thousands of others.
So how much does this all add up to? Researchers in America have worked out how much of their salary a group of teachers would need to set aside for a decent retirement. They reckoned it cost 12.5 per cent of the teacher’s salary every year to provide the collective pension; it cost 22.9 per cent if they took the individual pension. In other words it cost 83 per cent more to provide a decent retirement income using an individual defined contribution scheme, than it did using a collective scheme. The UK government actuary has done a similar calculation, and reckons the collective scheme will give 39 per cent more.
So what is the lesson here? To secure proper benefits we need a pension architecture that encourages the creation of big, low-cost, pension plans, which should be provided collectively to allow for appropriate investment policy. This will require trustee governance and the monies invested should be responsibly invested.
The prize is huge. It could lead, at no cost, to a 50 per cent or greater uplift in pensions for members at no extra cost. That’s the challenge the RSA will be setting and over the coming year it will be seeking to galvanise action towards this goal.
How you can help
To this end, we welcome input from RSA Fellows. There is one piece of information we would find very useful. We would like to know what the charges are on individual defined contribution pensions (and what people think they are).
So please do check yours, and tell us how much you think you are paying. Read the small print, and check all the costs. And send us what you discover, together with copies of the paperwork on your policy documents.
Over the coming year we will publish the best and the worst schemes. Perhaps in doing so we will be able to encourage better pensions in the future, and maybe even help you have a better income in retirement.
Please email information to Harinder Mann.
The RSA Tomorrow’s Investor project is led by David Pitt-Watson FRSA, and supported by an advisory board of Fellows.