Save for the future
It used to be so simple - you had a job for life, worked for forty years and then retired on a fat pension. Not any more. Not unless you happen to be one of the lucky few, these days largely concentrated in the public sector, who still gets a final salary pension.
Final salary pensions, also known as defined benefit pensions, typically operate on the basis that you get one sixtieth of the salary you are earning in your final year of work for every year of your working career. A full career is considered as 40 years, meaning you get two thirds (40 sixtieths) of your final salary as a pension.
Several things have conspired to make final salary schemes less attractive to companies. The principal reason is cost.
As life expectancies have increased, the
income that a pension fund can buy, in the form of an insurance
company annuity, has decreased. In fact, annuities bought at the age
of 65 are now as low as they have been at any time in the past 40
years.
A company looking to buy an annuity that would equal two thirds of
an employee’s final salary might need to pay twice as much as they
did 20 years ago.
As a result, at the majority of big British companies, final salary pension schemes are now closed to new members. The National Association of Pension Funds (NAPF), which represents providers of more than 1,000 occupational pension schemes with nine million members, says that 57 per cent of private sector final-salary schemes are now closed to new members. In its 2005 annual survey, the NAPF says that a quarter of all the schemes it covers plan to close to new members or stop existing members making additional contributions in the next five years.
Company pensions are now much more likely to be money purchase, or defined contribution, schemes where you and your employer’s contributions are used to invest in stock market funds. You still have to swap your fund for an annuity on retirement but the income you will be able to buy will depend entirely on how successful your pension fund investments have been over the course of your working life.
In principle, there is no reason why a money purchase scheme should not provide as good a pension as a final salary one although this will depend on you making sufficient contributions – although the indications are that most people do not do so – and enjoy a good growth in the stock markets over your working life.
There are also concerns about the latter. An annual survey produced by Barclays Global Investors (BGI) every year for the past 50 years shows that equities, i.e. shares and funds containing shares, have performed well over the long term in comparison to other investments such as government bonds and building society savings accounts.
One of the big worries for anyone trying to build up a pension pot is the risk of inflation eating away at what you have saved. The survey reveals that equities have proved the best hedge against inflation, compared with things like bonds and property, in the past but BGI has this year issued a warning.
“We caution that average historical returns data will not provide a realistic guide to future returns over the next 30 years. The unusual demographic outlook of a shrinking working population and an expanding dependent population suggests that the price of financial assets will fall relative to the price of goods and services. Consequently, equities may not provide an effective inflation hedge in future years in comparison to their past performance. The demographic outlook also calls into question the received wisdom that the problems associated with an aging society can be dealt with by encouraging ever-greater savings flows into financial assets.”
Too late to retire early?
Early retirement has always appealed to the
British public. The idea that when you’re in your fifties you can
tell your boss what you really think of them and then spend the next
twenty years swanning around the globe on cruise ships certainly has
a lot going for it.
Speaking at the Work Foundation Pensions Conference in February, the
work and pensions secretary John Hutton said: “There has been a
seismic shift in the balance between the proportions of life spent
in work and retirement. In 1950, the average male retired at 67 and
could expect to spend 10.8 years in retirement. Today he retires on
average 3 years earlier - at 64 - but can expect to spend a further
20 years in retirement.”
Over the next few years, retiring early is going to become increasingly difficult. While many pension schemes currently allow you to take pension benefits from the age of 50, from April 6, 2010 you will not be able to retire until you are 55 unless you need to retire due to serious ill health.
As Hutton implies, the change is linked to increasingly long life expectancies. Government statistics show that children born today can expect to live a year longer on average than those born just four years ago and five years longer than those born 20 years ago. By 2050, the average life expectancy for both sexes is likely to be in the mid-80s.
At the other end of the scale, enforced
retirement at the age of 65 is likely to change too.
In his speech at the pensions conference, Hutton said: “As unpopular
as it may be to talk about working longer – the simple fact is that
if we aren’t prepared to consider the option of increasing the state
pension age, we will simply pass an ever greater burden onto our
children and grandchildren…My view is that some increase in the
State Pension Age from 2020 is now inevitable.”
This is the first time that any minister has been quite so
forthright about changes to the retirement age. The most likely
outcome is thought to be an increase from 65 to 68, although any
change is expected to be phased in gradually, in the same way that
the retirement age for women is gradually being aligned with that of
men.