The Pension Crunch

The revelation that Fred the Shred’s pension is actually going to cost £30m, and not the £16 million quoted by RBS, has underlined a salient fact about pensions: everyone underestimates the cost of them. This is partly because the pension providers tend not to take inflation into account when calculating the lifetime cost of pensions, and make optimistic assumptions about investment returns. They know that if people are told the truth about how much they really need to save they run and hide.

You want numbers? A sixty year old retiring today and seeking a £30,000 a year pension, inflation linked, requires a pension ‘pot’ of over £1,000,000, according to fairinvestment.co.uk. The average pension ‘pot’ of a worker retiring today is actually £35,000. Do the math. Only bankers, politicians and employees of public corporations like the BBC get pensions that actually deliver. That’s because they don’t pay the cost of them - we do. One fifth of your council tax goes to pay the pensions of the people collecting it.

But central government is at it as well. The government claims that the current public sector pension bill is around £600bn when everyone in the industry knows that it will be well over £1 trillion. One of the untold scandals of the Brown years is the way that this colossal expense has been kept off the public books. It is “unfunded’ in the jargon, which means the government pretends it isn’t there. But of course it is there and someone has to pay for it: around £40,000 for every household in Britain over the next 20 years. The alert among you will notice that this is actually more than those people are saving for their own pensions - which is of course madness.

Now, I have no animosity toward public sector workers, who deserve what they get - which often isn’t a lot. However, we are creating a kind of pensions apartheid here. Nine out of ten public sector workers still have copper-bottomed final salary pensions against only one in ten private sector workers. The public sector pension used to be a compensation for lower pay in the public sphere, but that’s all changed. State employees now have higher pay than private sector employees and also work fewer hours. And the disparity is growing very fast in the current recession as a pay freeze is imposed across the entire private sector while public sector pay continues to increase. Moreover, the private pension savers have just seen the value of their pensions collapse in the stock-market crash by 40% or more.

Everyone knows that this cannot go on, but the government is in denial - just as it was about the housing market 2 years ago. The pension deficit could split society and destroy services like the NHS - it really is as serious as that. The root cause is the failure of successive governments to realistically cost public pensions and to regulate the private pensions industry, which has performed disgracefully over the last two decades. The average personal pension fund at retirement, according to Prudential, produces just £2,000 a year. And most of this is wiped out by the means test on the state pension credit - another disgraceful fiddle of which the government should be ashamed. And remember that forty percent of workers don’t contribute to any kind of pension at all and will be left wholly reliant on the basic state pension or £124 a week.

Many people have been relying on the value of their homes to generate an income in retirement. Well, the writing really is on the wall here because UK house prices have fallen 20% since August 2007, placing two million in negative equity, and prices are expected to fall by another 10-15%. No future government is going to allow another house price boom after the present disaster. So anyone who believes their house will look after them in retirement is living in a fool’s paradise.

I know this is alarming and complicated, and that pensions are about as interesting as programming a video recorder, but we ignore these numbers at our peril. I have been tracking my own personal pension for many years and been appalled at the poor returns - largely a result of high commissions taken by financial “advisers” and because pension savers are more or less compelled to place their money in equities to generate income for the pension providers. Every ten or twenty years shares crash and the pension funds rarely regain the lost value. Honest financial advisers - there are some - are deeply embarrassed about the poor returns from pensions industry and admit that most of the tax relief on pensions is diverted into salaries and bonuses for the pensions industry.

The terrifying reality is that, as Britain’s population ages, the means to sustain any kind of wellbeing in retirement is simply not there. Public sector pensions are unsustainable and private ones are risible. Our collective denial about pensions is similar to our refusal to face up to the debt problem during the credit boom. That too was clearly unsustainable, but the government and the financial services sector observed a conspiracy of silence about it - until it turned into a suicide pact. Voters are also implicated, of course, for thinking that houses would always rise in value, which is like believing money grows on trees.

Actually, the government is still hoping that trees can be persuaded to produce fivers instead of leaves. Last week the Bank of England began quantitative easing, printing money, which it hopes will generate inflation and erode the value of the public pension debt as well as the debts of the banks. What this really means is a transfer of wealth from people who have saved, to people who haven’t. It is a desperate and dishonourable way out of the pensions hole - and it won’t work. Inflation may erode the value of the public sector pension bill, but only at the cost of increasing entitlement, because it will throw more public and private pensioners into poverty and into the arms of the state.

From Weimar Germany to Mugabe’s Zimbabwe, the lesson of history is that inflation only makes large debts disappear at immense economic cost. There’s no free lunch. Future historians will be astonished that the government actually penalised savers at the moment when the country desperately needs to pay down debt and save for the future. But our children, as they pay for our mistakes, will look back on the noughties with a mixture of scorn and disbelief. We are generation dumb, and getting dumber.