Poor investment returns and dreadful annuity rates mean the outlook for defined contribution pension schemes is appalling
Two figures stunned me this week. The first was on Tuesday morning from the Office of National Statistics, which said that to buy an inflation-linked retirement income of £25,000 a year – less than the UK's average salary – you would need to build up a pension fund of £763,900 at age 65. Sadly, the median amount of money held in a pension fund is just £53,000, only enough to buy an income of £2,700 a year at 65. The pensions outlook for millions of people saving in "defined contribution" (DC) schemes today is, quite frankly, appalling.
Later in the same day, I was talking to a semi-retired police sergeant. He was 49 years old and had joined the Metropolitan Police at 18. He did not realise then that in the Willy Wonka world of British pensions, he was holding a golden ticket. At 48 years old, after 30 years' service, his pension has come in at two-thirds of his £40,000-plus final salary, with inflation-proofing on top. So he is already on more than £25,000 a year for rest of his life, uprated in line with inflation, without having to do another day's work.
To enjoy the same good fortune in a DC scheme you would have had to somehow save around £1.5m between the ages of 18 and 48 – or about £3,000 every month. Do you know any 18-year-olds doing that?
Was I envious? Of course. I will work much longer and pay in much more than a police sergeant, but am projected to receive a pension of much less than £25,000. Do I resent his good fortune? No. That was the deal then, and it's gone now. New police recruits retire at 60 with a pension on a much lower accrual rate and based on career average rather than final pay.
But there remains a huge chasm between pensions in the private sector (mostly DC) and those in the public sector (mostly final salary). The unions rightly remind us that the average pension in the public sector is £7,000, hardly riches, although double the typical £3,700 private sector pension. Many public sector workers are women who take career breaks (I think that's the modern word for having children) and don't build up fancy entitlements.
But the unions should not use those facts to defend the bumper payouts to higher-paid public sector workers. Figures obtained by the Intergenerational Foundation last year found that nearly 80,000 public sector retirees are already collecting pensions worth £25,000 or more, and more than 12,000 have pensions worth above £50,000 a year.
There's nothing wrong with a high pension, if you worked and saved for it. But the police, for example, under the 1987 scheme paid in 11% of salary. Even with employer contributions, there is no way that added up to the payouts being received today.
Wrongly, the people who are paying for this are the younger generation. Existing pension entitlements are considered inviolable (why?), so younger people have to work longer for less, and somehow pay for inflated house prices.
Sneering at public sector workers is not the answer, although capping higher pensions would make sense. Maybe the state should agree to underwrite a pension of up to £25,000, but anything above that could perhaps come without a guarantee and depend on what the contributions earn.
The problem with pensions is less the future liabilities of the public sector, which post-Hutton reforms have gone some way to reducing. Instead, it's the catastrophic mix of poor investment returns and dreadful annuity rates for those in the private sector who can afford to pay in.
DC pension schemes put all the risk on the individual, with the employer underwriting nothing. An oil rig disaster for BP in the Gulf of Mexico? The worker in a DC pension scheme pays for it, but it matters not a jot to someone with a final salary scheme. We need a middle way, a hybrid that gives workers in DC schemes at least some guarantees about future outcomes that those in the public sector enjoy.
What's clear is that the current set-up has failed, with annuities no longer fit for purpose. No one ever expected interest rates to go so low and stay so low for so long. Paying £750,000 for a £25,000 income just doesn't make sense. But what, apart from the 3.15 at Newmarket, is the answer?