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)
I disagree with both Messrs McPhail and Gilchrist. 25 years of destructive government meddling, combined with the relentless decline in annuity rates, has pretty well shot to pieces public confidence in just about everything to do with pensions. Stakeholder was arguably the worst thing of all, removing all incentive for intermediaries to sell pensions, combined with the removal of Contributions Insurance and the facility to include some life cover. Crash Gordon's £5Bn+ annual tax raid on pension funds hardly helped, not to mention the imposition of a raft of unmanageably stringent rules on how employers must manage the long term solvency of DB schemes. And what about the current government's total failure to honour the Conservatives' pre-election manifesto pledge to put right all this damage?
How might the entire pensions framework be redesigned ~ effectively ~ from the ground up? Mr Gilchrist offers no suggestions, just his usual windy platitudes. So here are some suggestions:-
1. Repeal the £5Bn yearly tax raid on pension funds.
2. Perhaps offer a 5% enhancement to basic rate tax relief on pension contributions.
3. Remove the punitive 55% death tax charge on unspent funds post vesting.
4. Allow unspent funds to pass tax free down into PP's for the next generation.
5. Restore WoP insurance.
6. Restore life cover as an integral part of PP's, subject to a minimum ongoing level of contributions to retirement benefits.
7. Remove the threat of the lump sum option at retirement being taxed.
8. Address the problem of dire annuity rates by issuing high yielding gilts available only to annuity funds.
9. Restore the incentives for intermediaries to actually promote and sell PP's.
10. Simplify contributions limit to 30% of earnings, with one year's carry forward of unused allowances from the previous year.
11. Remove the LTA. And then.....
12. STOP MEDDLING.
So there we have a 12 poiny action plan ~ of which the government is likely to take no notice whatsoever.
I fully endorse Julian's ideas especially number 12. It seems to me that pensions need constant revision and revising simply because the legislation changes all the time.
However, I think even Julian is wide of the mark. We need to scrap pensions entirely and replace them with an ISA style savings scheme. Tax free benefits on retirement but access to taxed money if needed beforehand.
Money Marketing is for financial professionals, so naturally, the perspective written on this blog is generally for the financial cohort.
However, the public decides for itself and indeed has broadly decided that pensions are a 'dodgy deal' and what little money the public has to 'put away' is finding a home in ISA's.
Very few financial professionals appear to be able to accept this fact, apart from, notably, Ros Altmann of Saga.
I agree Soren.
Saving for the future in the knowledge that there is accessibility, if needed, is the obvious way forward (ISA).
To attract long term thinking I suggest that the government gives a bonus after ten years, and again every five years thereafter, importantly based on the individual contributions made, and allow the employer to contribute.
Forget pensions. Forget tax relief on contributions. Keep it simple. and yes, stop meddling.
“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"
Phew!!
What a lot of guff.
Simple proposition to clients - do you want a comfortable retirement and if so, how much are you now prepared to set aside and sacrifice to achieve that goal.
Once the goal has been set and the percentage of savings established, the adviser can then calculate using proprietry software packages, how far along towards their goal their stated savings levels will take them.
No one ever said this job was easy, but the gobbledegook employed in the statement at the beginning of this response, clearly demonstrates how far removed from Joe/Jane Public we are, when we come out with such phrases. God helps them if a client reads this stuff.
We have to make it simple to save, employ our professional judgement as to whether a client has a realistic set of goals or whether they are unachievable. Only then can any sensible discussion on savings come about.
PLUS - with the current economic climate and all its threats to financial stability of the country and individuals that implies, not a lot of Joe/Jane Public have much spare dosh.
Ned lits the nail on the head but underlines some of Chris Giilchrist's points about behavioural finance at the same time. HOW do we encouyrage people to save sufficient for their retirements?
Julian's wish list sounds hopelessly unlikely to gain political favour - BUT - the question is do governments really want to encourage saving for retirement and, if so, why are they not doind (rather than talking) more about it? Even some of Julian's 12 points would start to make a difference.
People don't save but can be SOLD savings products. People dont save enough, so lets decimate the IFA sector who give advice based on need on a face to face, personal basis and replace with a MAD sorry, MAS website. That'll do the trick!!!
if there are any policticians or policy makers out there reading this, will you please start to listen to the people that are on the front line trying to do the job.
IFA's are stuck between two rocks (FSA and the FoS) and a very hard place (the FSCS) with no long stop in sight.
Seems to me that the only sensible market for IFA's in England now are the VHNW and HNW individuals.
Good independent financial advice for Joe Public will post-RDR be very hard to find unless Joe is prepared to pay upfront, which seems unlikely.
Both Chris Gilchrist and Julian Stevens make good points, but perhaps the best is made by Anonymous (5:09). From January the mass market is irrelevant to the IFA community as a direct consequence of the FSA's over indulgence in regulation.
So why are professional advisers using these financial pages to discuss what is a social and political issue.
The never ending interference of UK politicians will always ensure that the mass savings market is in a state of turmoil so there is little point wasting time and energy commenting on these matters in these journals. There are a thousand ways to improve the current pension regime. Politicians will find a thousand and one ways to ensure they do not work.
So back to concentrating on doing a good job for those rich enough to pay you for working on their behalf - and perhaps offering up a thanks for the interfering politicians who make your work necessary for that privileged few.