In January both share prices and government bond prices fell. This meant that most pension funds in the UK lost money, some of them very large sums.
In the through the looking glass world of pension calculations, the deficits of the UK funds actually fell a little. The combined deficits of all the funds coming under the Pension Protection Fund reduced from Ā£194.5 billion to Ā£`190 billion. This is because as government stock prices fall, interest rates rise. This is taken as good news for pension funds, meaning they might to be able to buy more income in the future for any given amount of cash.
It still seems to me losing more money by holding bonds that go down is bad news for them. If they had held more cash they would be in a stronger position today, able to buy bonds or most other investments at cheaper prices. I fully agree with those who work out the sums that losing lots of money in equities was unqualified bad news for the funds. In 2008 overall they lost 14% from holding equities, and in January 2009 another 3.7%. February so far has brought no relief from the plunge.
Why does all this matter? You could say these sums are all notional, that one day markets will rise again, that most companies will meet their obligations to present and future pensioners over the long haul. If you took such a relaxed view, you would be missing the serious crisis now facing many companies with final salary pensions.
The UK government set in train three different policies which have combined to undermine final salary pensions.
The first was the Pensions tax on investment income, costed inaccurately at around Ā£ 5billion a year(the government refused to let us have the true figures). This removal of substantial income from the funds both hit their earnings on the investments, and helped drive down the capital values of the shares so taxed. If shares yield a large class of investors less income, it usually means they are worth less as a result. The funds also had less investment income to reinvest, so cumulatively it became a big hit.
The second was the decision to set up a Pension Protection Fund with powers to levy an additional tax on successful pension funds, to pay for the funds that got into financial difficulties. The danger today is that more companies will go bankrupt, placing their pension funds in the hands of the Protection Fund. This could strain the resources of the Fund further, requiring ever bigger levies on the funds that are still being supported by their sponsor companies. Sponsor companies strapped for cash to run their businesses will not only have to tip more money into their own fund, but will have to find extra to pay for other peopleās funds that have got into an even worse mess.
The third is the regulatory system developed by the government. The Regulator for understandable reasons demands repairing the damage done by falls in values of investments within a limited time period. It means that companies have to start filling in pensions black holes whilst they are still struggling to generate cash in their own businesses. There becomes an unintended additional pressure on the company itself, where the demands for larger contributions to support the pension fund could be one of the straws that breaks the camelās back in companies running out of cash.
Keeping the company going is probably the best way to underwrite the pension fund. Taking too much off the company to buttress the pension fund may make short term sense for the fund, but may make the longer term position worse, placing yet another fund into the hands of the stretched Pension protection fund.
What should we conclude? We can conclude that there is no substitute for pension funds making or preserving their investment money, and no substitute for each pension fund being backed by a strong company. The present combination of regulation, taxation and poor economic circumstances will spell the death knell of quite a few pension schemes, as well as the companies that went with them.
It will confirm the corporate sectorās view that final salary schemes cannot be afforded and are too risky. They are going to be a phenomenon primarily of the public sector where people still think money grows on trees. In the meantime, if the government wishes to save some pension funds and ward off more corporate collapses, it needs to do some constructive thinking about the system of creeping death it has invented for so many pension funds. If it hadnāt bought so many bank shares it could afford to do more to help. The problem is the government itself is showing itself to be a worse investor than Pension trustees, capable of losing more money more quickly.
February 22, 2009
We have been telling clients all this for years. Now, they are listening.
You really could not conceive that any government coud be quite so stupid.
February 22, 2009
I have often wondered just how expensive the abolition of tax relief on dividend income has been for pension funds. As you point out, Mr Redwood, the effect is cumulative because reducing the income to the fund reduces the amount it can invest which reduces next year’s income, which reduces the next year’s investment, which reduces the following year’s income and so on.
There are those who argue pension funds should not have any special dispensations. But in a country with a systemic problem of funding the retired, that argument seems flawed to me. We should be looking for ways to increase pension funds, not reduce them simply because other forms of investment are subject to tax. If anything, we should be aiming to release the other investment schemes from tax so that there is a noticeable benefit for the thrifty.
What is often overlooked is that most private pensions are not fat-cat gold-plated Rolexes in disguise, they provide a modest sum to top up the meagre state pension. Tax policy should always concentrate on benefitting those at the bottom of the pile. An additional Ā£20 or Ā£30 a month really matters to many pensioners and to think they have been deprived of it so that an anomaly in the tax system could be removed is, to my mind, obscene.
Sadly the likely depth of the current recession/depression will not easily allow tax relief to be restored for many years. The pensions problem will, I fear, become more and more stark over the next decade. It could have been protected well from current difficulties had Mr Brown not extracted his pound of flesh on Day One and thrown the money at wasteful (and failed) social engineering projects.
February 22, 2009
JR wrote:
> The second was the decision to set up a Pension Protection Fund with powers to levy an
> additional tax on successful pension funds, to pay for the funds that got into financial
> difficulties.
Companies A, B, C and D decide to set up their own pension funds. Some of the employees of each company decide to pay money into their companys fund, so that they will have a nice pension. The companies, to help them and as part of their remuneration, match their contributions.
All good and well.
Then Party E comes along. He tells Companies A, B, C and D that now, on an ongoing basis, some of the money employees pay which is going to their pension funds will now be taken and if any of the pension funds run into trouble, that money will be used to bail them out.
In other words, Party E has just made every pension fund responsible for bailing out every other pension fund.
*What if the pension funds didn’t want this responsibility?*
What right does an arbitrary third party (Party E) have to come along and force a serious financial obligation upon privately owned assets?
Was it because it’s “for their own good?”
If these funds wanted to mutually support each other, *they would have done so by themselves*. Those that have wanted to do so can do so; those that do not do not have to.
To force it upon them all is profoundly *unfree*. Freedom is where individuals make their own choices about what to do with what belongs to them. Every time a third party comes along and *forces* behaviour, freedom is thrown away – for the choice has been made by someone else and forced upon you. Who runs your life? you, or the Government?
February 22, 2009
How different is the pension schemes for the self employed.
Only the future pension holder makes any contribution (other than tax relief), they choose what they save within specified and allowed limits, and so thus have control over the eventual Fund (subject to performance) which purchases an Anuity.
As you can see there are enough variables in this method.
How many people would sign up with any other form of contract without knowing a single thing is fixed or guaranteed.
In effect you take out a lifetime contract not knowing how much you will contribute (as you are not aware of future earnings).
How long you will contribute (you do not know when you will retire)
No form of guarantee of fund performance is promised (it can go up or down).
Rules can be subject to change at the whim of the Government or Inland Revenue (historical fact)
The money is locked away so that you cannot use it should emergencies occur (unless you retire).
The Insurance Company may fall upon poor times (Equitable life)
The Insurance Company may impose charges (MVA) should you wish to transfer for poor performance reasons (most Insurance Companies)
You may not survive to see any payment or benefit at all.
In short the client takes all of the risk.
Complicate this where a final salary scheme promises a final amount of your salary, where the employer pays for everything, or in the case of a defined scheme contributes significant percentages of salary, on top of the salary, as well as taking the risks, and the difference is obvious.
The Company takes more of the risk.
No wonder we are seeing Black Holes in Pension Funds when the Company is trading in hard times and making little or no profit.
A Company is usually in business to make profit out of which it can grow.
A good business also looks after its employees, but it has to make profit its King, as otherwise nothing is sustainable.
Pension Funds need to be safe under Legislation, but be careful that you do not kill of the goose that layed the golden egg by over Regulation which complicates things even more and adds cost.
February 22, 2009
Do the public sector workers really believe they will receive what they have been promised? In 30 years time the number of workers to dependants falls from 4 to 1 now to 2 to 1. Who will pay the taxes especially as the private sector employees have no pension and will need to be funded as well!!!
I also think that when companies are wound up, the pension scheme should be first in line on the creditor front even if other creditors have calls on fixed items.
The pensions disaster is Gordon Browns legacy to the country.
February 22, 2009
Why not sell all the bank shares and come to think of it the Post Office , the BBC ( good riddance ) and Channel 4 ( ditto). All the money raised could fund a flat rate top up to all UK pension funds to guard against any harm done by a weak stock market.
To add an average of roughly Ā£11,000 to each workers pension fund why not boost share prices by exempting deals in shares from stamp duty entirely by axing that tax ? The Tories could be a bit bolder by not only killing off basic rate tax on savings but also killing off 20p tax on incomes from shares/dividends and pensions too. That would boost share ownership ( and by taxing it less you get more share deals , a higher price and bigger pension pots to boot) and more pension saving ( if people thought that they would get a tax free income by saving for a pension you would create a major incentive for pensions saving by axing unfair double taxation).
The public sector retirement age and the state pension age to take account of the demographic imperative could be raised in stages to 68 over ten years. The result would be lower public spending on pensions in the longer term.
The way out of this mess is to reform taxation so that private pensions saving expands while stopping government expenditure on public sector pensions & the basic state pension getting out of hand.
In the longer term it might be wise to slash red tape & pensioner poverty while rewarding saving (i.e. axing means-testing ) by replacing all state benefits for the retired with a flat rate Citizenship Pension linked to earnings or prices whichever was greater set at levels designed to stop anyone aged 68 or older from being in poverty. With no means-testing more might save for their old age safe in the knowledge that their state benefits where not affected. This would mean fewer rules & regulations and lower admin costs as if it was simpler than the present set up then you would need fewer people to manage it. That would help cut down the state sector payroll – having fewer people working for the state now means lower public sector pensions expenditure in the years ahead. So freezing civil service recruitment , axing as many QUANGO’s as possible and ending things like RDA’s & the New Deal might help.
By replacing Job Seekers Allowance & Incapacity Benefit with one payment designed to reduce unemployment my making economic inactivity financially unattractive you get more people of off welfare dependency making a Citizenship Pension more affordable. Also action on reducing long-term unemployment would offset any addition to the dole queues caused by cutting public sector jobs.
So cuts in public sector employment , some tax reforms and real welfare changes can diffuse the pensions time-bomb. Will David Cameron , George Osborne & Philip Hammond , Theresa May and the soon to be Lord Freud follow this sound advice I wonder ?
February 22, 2009
Look at the state pension. If the NI associate with the average worker had been put into the FTSE, a pensioner retiring today, even with the crash, would have a pension of around 24K.
That’s the extent of the government rip off. They have ripped people off by 19K a year for their retirement.
Until you are open and honest and tell people the reason they are having a poor retirement is that you took their savings and spent them, not invested where they benefit from compound interest, the public has every right to do what it can to avoid giving you any tax.
February 22, 2009
I wonder if funds losing the income from the Pensions tax has exacerbated the problems with the banks i.e. through institutional shareholders seeking greater return on their investments and encouraging higher risks to be taken.
February 22, 2009
Another point which is often missed is this:
They abolished tax relief for dividend income, but not for loan interest income. As a result, it is now more tax efficient to receive income from pension investments as loan interest rather than dividends, whereas previously it was tax neutral.
This must be at least part of the reason why private equity funds and others geared up company balance sheets as high as possible rather than using equity capital to fund their operations; and hence part of the reason why a lot of these companies are going bust rather than merely having reduced profits.