Time to blow our pensions trumpet
Our pension system will, I hope, one day be reformed so that we can all properly understand the pension products we invest in, but even with our imperfect system we have done something in the UK that makes us quite unusual compared to the rest of Europe. Those of us who have put money aside for our pensions have saved between us over a trillion pounds in funded pensions arrangements. That’s over a thousand billion pounds and is more than the amount saved in every other country in Europe added together. We are the most pensioned people in Europe, but not so you’d notice from reading the general press comment that seems to plague pensions. If you believe what you read in the popular press, pensions is all doom and gloom. Well, I don’t think so.
First things first. People investing in any form of pension saving in the UK get tax relief up-front. So, and just to spell it out, a forty percent taxpayer putting sixty pounds into a pension gets one hundred pounds credited; a sixty-six percent increase in the investment straight away. Now, before you all start writing in, I know that the immediate credit the pension scheme receives is only the grossing-up at the standard rate of tax and that the difference between the standard and higher rate of tax is credited to individuals by other means through the tax system, but it amounts to the same thing. Try and ignore the complex details, stand back and concentrate on the principles involved. A sixty-six percent immediate return on the investment is what is on offer for higher-rate taxpayers. That’s outstanding and unbeatable by any other investment we can make.
It’s nothing new, it’s a right that’s been available to us since the middle of the last century. That’s the trouble with it, I think, we’ve been offered tax relief on our pensions for so long we’ve forgotten how powerful
it is to have it. Indeed, if up-front tax reliefs had never been on offer to us and they were to be introduced in the Chancellor’s current budget we would probably never read about anything else in the press for ages - it would be a front-page story. So would the fact that our pension savings are allowed to grow in a largely tax-free environment. Not as tax-free as it used to be, I know, but again let’s try not to be too picky; this is an upbeat piece on pensions for a change if you remember.
The combination of more money being invested than you actually put in and the greenhouse effect of tax-free growth, together with the magic of compound interest, makes investing in pensions something special. That’s why we’ve put so much money aside in the UK. It’s a no-brainer.
But wait a minute, I hear you say, what about all the doom and gloom everyone else is on about all the time? There’s no smoke without fire, right? Well no, not really. Again, if you believe the popular press, there is an ‘annuity crisis’ affecting us at the moment. It is a good story because it is bad news and quite unsettling for the millions of people who read newspapers and also save in a pension scheme for their future. The so-called annuity crisis is an excellent example of how the combination of two very good pieces of news for all of us can be turned into a piece of bad news by people who don’t properly understand how pensions work.
An annuity is an insurance product, a true insurance product. When you ‘buy’ an annuity you are insuring yourself against living longer than your savings. An annuity guarantees you an income however long you live. The level and form of income is fixed at the outset and for as long as you live the payment of the annuity is guaranteed. OK, so some of us will live longer than others and get better ‘value’ out of the deal. Well yes, to a point; where mortality rates can be predicted for the population as a whole, they can’t be used to predict particular lifespans for particular individuals. That’s the nature of insurance. People don’t ‘buy’ annuities, they insure their lives.
Annuities, however, have suddenly become more ‘expensive’ and that is what the current ‘crisis’ is all about. What has actually happened, though, is really good news for all of us. The fact is, we are all likely to live much longer than people used to live in the past. Indeed, once we reach the age of sixty these days no bookmaker would ever take a bet against us living to age eighty, the odds are he would lose more often than he would win. That’s great news for us all and should be front-page news in the popular press. The other piece of good news that affects the perception of annuities is that we are living in a period of long-term financial stability where inflation has finally been brought under control all around the world. No more real crises of spiralling inflation to make our lives miserable and our futures unpredictable. Another piece of good news affecting us all that should be front-page news, but isn’t.
All we hear about, unfortunately, is the annuity ‘crisis’ and how annuities Aren’t such good value as they used to be, so what’s the point of saving for the future?. The people who are saying these things are really saying that we were better off when we used to die earlier than we are now likely to and that we were better off when inflation governed our lives. Do yourself a favour; don’t go along with their argument. It sounds plausible, but if you really think about it, it’s a load of twaddle.
First published in Bloomberg Money, May 2002