Biscuitman

PENSIONS MELTDOWN

By David Lamb. December 2004.

2) Outside the Nanny state.

So much for the State Pension, what about Personal Pensions and Company Schemes?

Well in the first place, nobody wants a pension. What we do want is income in retirement and that means arriving at that magical day with enough savings, from whatever source to fund that retirement.

Between starting work and getting the golden handshake we have to make a trade off of what we want to spend now and what we want to spend then. Trouble is we don’t know how much we will need in our retirement, how long our old age will actually be and for how much of it will we enjoy reasonably good health.

A common way to accumulate a sum of capital used to be to take out an endowment plan that would mature on your chosen retirement date and then receive an income from the plan for a set number of years. This was superceeded by the introduction of Retirement Annuity Contracts, (RACS). These introduced the concept of tax relief on premiums paid.

Tax relief is in fact a myth. What taking out a pension plan means is that you are deferring taking part of your income now, it is to be held in a pension plan until your retirement, when you will take it as income. Thus if you don’t receive income now, the revenue cannot charge you income tax. But, unfortunately the word deferred comes before income and on taking your pension at retirement the income is taxable. So it’s tax deferred not tax-free.

Still it’s a good concept and should encourage savers to fill their boots. Unfortunately the flaw is that although you know what ‘tax relief’ you are getting today, you don’t know what the income tax rate will be when you start receiving your pension income. I’ll make a bet with you; it won’t be a lower rate than todays. So we will nearly all end paying income tax in retirement.

Personal pension plans as we know them today were introduced in 1986 and no new RACs were issued after that date. The idea being to shift the responsibility of providing pensions from the State to the employer and employee. The 1986 Act re-introduced “Contracting Out” of the State Secondary Pensions Scheme and incidently reduced SERPS benefits, in order to provide a foundation payment to encourage the population to add their own money to.

The basis of Personal Pensions, which are also known as Money Purchase Schemes and include some company schemes, is that they are defined contributions, that is you know how much you and /or your employer is paying in and the pension you get is based on however much your pot has grown to.

Personal pensions, with their variations, (Sipps, Ssas, GPPS etc.), ticked along, virtually unchanged until the introduction of Stake Holder pensions, which are pretty much the same thing but with, generally, lower charges and easier access.

The main difference under Stakeholder rules being that the lower paid, the unwaged, carers etc. etc. could fund their pensions by up to £234 a month and have the Inland Revenue round that up to £300 a month, whether the plan owner was paying tax or not.

Quite a good incentive, unfortunately most personal Stakeholder schemes have been sold for the benefit of children, using the child benefit, or grandchildren and the non working wives of people lucky enough to be funding their own pensions to the maximum.

There was also the requirement for employers with more than five employees to put a company Stakeholder scheme in place with the threat of a £10,000 fine for any who didn’t. Unfortunately there was no compulsion for contributions to be made by the employer. As a consequence of the 400,000 Company Stakeholder Schemes that have been designated 75% of them are ‘empty’ and have not received a penny in payments. Worse still, of the 100,000 ‘live’ plans only 4,000 of them receive employer payments.

From the 1960’s employers started introducing company schemes and these fall INTO phpbb_two categories, Money Purchase schemes, which I explained above are where the employer pays a fixed amount of the members income INTO phpbb_a pension plan and the costs are known. They are a form of personal pension and are usually supplied on a group basis.

The other category is called Final Salary and they are known as Defined Benefit Schemes. (For the purpose of this discussion I am ignoring variations such as Executive Pension Plans and I’m not even going to mention FURBS and UFRBS – whoops I just did!).

Let us look at those provided by Private Sector employers first. The schemes are known as Defined Benefits because the scheme rules state the rate you are accruing benefits so you know what to expect at retirement.

The cost to the employee is usually fixed at either 0%, 5% or 6% of earnings. The employers contribution is assessed every three years when actuaries value the schemes assets and accrued pension liabilities. The employer then has to make a contribution to make up any difference.

There are two common accrual rates, either 1/60th or 1/80th of your final salary for every year of service.

Under a 1/60th scheme however, if you want to take tax free cash at retirement, (usually limited to 150% of final salary), then you get a reduced pension which effectively gives you 1/80th of final salary for each years service.

The other is a 1/80th scheme, which is the reverse of the 1/60th scheme in that you have a tax-free cash entitlement which, if you give it up, effectively changes your accrual rate to 1/60th. (Pensions are easy aren’t they!)?

As for those Public Sector Schemes, although some are being run on a funded basis, such as the Local Government Pension Scheme, frighteningly none of them are adequately funded, most schemes are unfunded including The Teachers Scheme and The National Health Service Pension Scheme. i.e. the employee may or may not make payments INTO phpbb_the scheme but the employer, that is the ‘Government’ in one of its many forms, does not make any actual payments INTO phpbb_the fund.

When benefits become payable they are paid out of the contributions the employees are making and the ‘employer’ – effectively the taxpayer, pays the shortfall. These are known as pay-as-you-go schemes.

As a quick aside, there is another accrual rate that applies to the Public Sector schemes for a select group of employees and that is a 40th scheme. Which means if you accrue 30 years service then you retire on the maximum allowed of 2/3rds of your final salary.

Who receives this ‘Rolls Royce’ of a pension? Why MPs of course. They recently increased it from being a 50th scheme to reflect shorter parliamentary careers. With MPs salaries currently just under £60,000 a year that means a nice £40,000 pension. Plus any Public Service, i.e. working for a council or health authority etc before they arrive at Westminster is added to their parliamentary service in assessing their pension benefits.

An interesting point was that at the time that our MPs awarded themselves an increase from a 50th to a 40th scheme they reduced the Principal Civil Service Scheme from an 80th with tax free cash to an 60th with tax free cash. A reminder of who are the masters and who are the servants.

The amounts the UK has in pension schemes is £1,500 billion in personal and company pensions, £500 billion in unfunded liabilities for public sector pensions and a further £1,100 billion in State Pension entitlements.

Despite the efforts of successive governments, we have been quite prudent in our pension planning and this looks a pretty healthy situation so why is this piece entitled “Pensions Meltdown”?

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mkpdavies

This is a very interesting read! What is does emphathise, is whatever rules you are playing to today, will be totaly irrelevant to the ones you will have to follow when you retire.

For me the UK is in a stronger position than most when it comes to pensions. This doesn't mean we should treat it as a cash cow to raid to fix other problems. All governments sadly have done exactly that, but even more concerning is our membership of the EU.

Look at the figures for all the other countries pensions, and you can see that our problem not really a problem at all, compared to their nightmare scenarios anyway. If we join in fully with this EU social/communist project, all our nation has worked for will be handed out and we will take on the rest of Europes liabilities.

Will this make Britain a better, nicer placer to live? No, it will ruin us, and all people have worked for today, will be for nothing, as we will all be on the breadline, just like the Soviet Union and it's plebs.

UKIP have to put rules in place to stop pensions funds being treated as a political football. If you save all of your life, it is fundamentaly wrong to tax these savings, and means-test people after they have done their best to provide for themselves.

I will look forward to the rest of Biscuitmans posts on this subject!

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