Chris Gilchrist: Long-term saving needs a radical rethink
Pension boffins like Tom McPhail argue that the defined-contribution pension industry has all the tools it needs to provide good savings schemes for everyone. I fundamentally disagree.
In their current guise, pension schemes are not a solution at all. They need to be redesigned from the bottom up to suit people’s needs rather than being fitted into yesterday’s economic theories and models.
The basic presumption of politicians and the industry is that of the prevailing neoclassical economic model. If given the right choices, rational self-interested humans will make the best choices they can, which will produce the best possible outcomes. People will understand, if politicians and the industry bang on about it, that they need to save more. If this requires spending tens of millions of public money every year on education, it is a necessary part of the process.
The politicians have convinced themselves that by simplifying the choices, they have created the right incentives. Having a flatrate state pension instead of means-tested top-ups that removed incentives to save means people face the choice of saving or being poor in their old age. Surely, that is a no-brainer?
Of course, it is not a no-brainer at all. On the contrary, all the evidence from behavioural finance shows people will not save more even if the choice is that clear. They will not do so because we are hard-wired to hyperbolically discount and hugely overvalue a pound today versus a pound in a decade or two decades’ time.
On top of that, savings decisions require long-term commitment - which we are bad at - and involve complex calculations, which fewer than one in 20 adults are capable of following. Faced with those difficulties, knowing - on the basis of a generalised awareness of bad headlines about pensions over the past decade and more - that pensions are troublesome and problematic, and having a limited amount of time they are prepared to spend on any financial decision, most people will never engage with the pension savings decision. Ever.
We are not talking about the IFA clients here. They are not part of the problem. We are talking about the non-existent mass market for long-term savings schemes of any kind.
Where should we start? First, recognise that big financial decisions are social rather than financial, by which I mean they can and should involve a wide range of people and that people’s decisions are heavily influenced by those of their peer group.
Second, that “unbundling” along DC lines, which multiplies choices, is against the interests of most people because they will make sub-optimal choices as a result of behavioural biases.
Third, that incentives need to be simple and calculable by people with minimal mathematical skills.
The lines of a possible solution then emerge as follows - socialise, mutualise, reward. Socialise means embedding long-term saving in society and directly linking long-term saving to investment in its proper sense, that is, new capital directed to production. Mutualise means building large-scale member-owned institutions to capture economies of scale and build confidence in long-term sustainability and equity. Reward means linking financial incentives to the behaviour - if long-term commitment is what we want, why give all the reward up front in terms of tax relief rather than gearing it to the term of the savings?
Only when we get radical rethinking on these lines will we be heading towards a solution to the long-term savings gap.
Chris Gilchrist is the joint author of The Process of Financial Planning and editor of The IRS Report
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Readers' comments (14)
AS an outsider to this part of the finance world I thought te article fairly sensible, and some of the responses near to unintelligable (sp?). Ned Naylor gets it right whan he talks about the gobbledeygook being talked.
We need simple cheap to administer products that folk can understand, and we need a hard message to go out to the punters that most of them are heading for penury in old age. Saving for a pension has to be made compulsory or it won't happen on a wide enough scale.
Of course to do that something has to give, and that ought to be the cost of housing. An unholy combination of banking regualtion (basel III) and an economically unresponsive planning system conspires against the public good, and has to be dismantled. then home will be come cheaper and people will be able to afford the required rate of savings.
My wish list may well be optimistic BUT the government is doing virtually nothing to address its apparent concerns that people are not only not saving enough for retirement but increasing numbers are saving nothing at all.
The Conservatives promised in their pre-election manifesto to put right all the damage done to public confidence in pensions by 25 years of meddling, yet all the coalition has done is to press ahead with NEST which, IMHO, just isn't the answer.
Why was WoP scrapped? It was a low cost yet potentially valuable supplement.
Why was PTA scrapped? It could and should have been retained (subject to a minimum level of ongoing contributions to retirement benefits).
What effect, other than negative, did the government expect taxing dividend income to have?
Why shouldn't unspent funds, post-vesting, be allowed to pass down, tax free, into PP's for the next generation? Wouldn't be so much better if people could know that even if they don't reap the full benefit of their accumulated pension funds, at least their children will?
Why is the government in a state of apparent paralysis when it comes to reforming how funds may be deployed for the provision of retirement income?
How can the threat of taxing the lump sum option at retirement be seen as anything other than hugely negative?
Having admitted that a top rate of income tax of 50% has yielded hardly any additional revenue, how much revenue would the Treasury lose if the input cap and LTA were scrapped?
Stakeholder, by and large, has been a flop ~ why? Because long term savings plans aren't bought, they need to be sold. Most people of modest means won't/can't pay a fee for advice and most pension plans now contain no facility for the cost of advice to be built into the product, so there's no incentive for intermediaries promote them.
The list of reasons for not embarking on a long term retirement savings plan is both long and dispiriting. I just don't understand why the government cannot see this and why it refuses to take action to encourage people to start saving again.
Remember KISS?
Public Service Broadcasts to get the message across and simple products should do the trick
David Cameron take note
I agree what most of what Mr Gilchrist has written. Basically he is not referring to our clients, but to what many of us refer to as ‘the great unwashed’.
There is a well-worn adage – “No one got poor underestimating the intelligence of the British Public”.
My take on what Mr Gilchrist wrote is that any hope of altering people’s behaviour in this respect is probably doomed to failure. What worked in the past – high pressure sales techniques which these less than cerebrally endowed fell for, may in retrospect, have been somewhat better than the current situation. But the world has moved on.
This then leads to a somewhat different conclusion than the article in my view. Presuming we have an honest Government (is this a chimera?) then just raise taxes and have a reasonable state pension that is properly funded by ring-fenced tax receipts – along the Norwegian model. For those willing to engage then allow full tax relief on contributions and halve the tax rate on pensions in payment. And finally – as Julian so pithily put it – STOP MEDDLING.
I know we live in a caring, sharing society. But a significant part of the problem is that we have forgotten that failure should not be rewarded. Even the most obtuse will realise what needs to be done if they see others in dire straits. The myth that will still have a Welfare State needs to be dispelled.