Fool's Eye View

[ June 13, 2000 ]

The Pension Knowledge Gap

By Stuart Watson (TMFTiger)

Great Titchfield Street, London -- We seem to be inundated with press releases here at Fool HQ at the moment. Many of them are just fit for kindling, but one that caught my eye recently was a release from Barclays Global Investors about pension scheme awareness in the UK. Like all releases of this nature, it makes scary reading.

Pensions, yuk!

Regular readers will know that we are not particular fans of personal pensions, which have high charges and are about as flexible as Arthur Scargill. We don't like the fact that you are forced to buy an annuity with a pension. This study concentrates on company pension schemes. They are a little bit more Foolish, as your employer often helps you out by coughing up some readies as well. Barclays spoke to 500 members of money purchase pension schemes asking them how much they knew about them and how confident they were about their prospects.

It was encouraging to see that 89% no longer take government pension provision for granted. A recent study on "Saving for Retirement" by the FSA makes this clear as well. Its opening sentence consists of this rather stark warning: "The State will not provide an income in retirement on which many people would be content to live." You can't get much clearer than that. But 87% of those asked felt comfortable that their pension would provide them with good returns. Well, that's alright then.

However, reading on we discover that 74% do not know how much their pension scheme is worth and 53% do not know how well it is performing. Given this lack of knowledge the confidence in their pension providers seems generous to say the least. It seems even more generous when you consider that 45% did not actually know who their pension providers were.

But it gets worse. 20% don't know how much they are investing and 24% don't know their company is contributing. At the moment the knowledge gap looks more like a yawning chasm. Of those that do know how much they are contributing, three-quarters are putting in 7% or less of their salary. The average amount being put in by companies looks to be around 6%.

So how much can you expect to retire on?

It is difficult to draw any firm conclusions about the adequacy of these amounts. The individuals concerned may have other forms of savings for example. But we can have a stab. Average earnings in the UK at the moment are around £25,000. If you save 7% of your salary this represents a whisker under £150 per month.

Say you save this amount for thirty-five years; how much could expect to receive when you retire? This is where the compound interest calculator comes into play. Naturally your rate of return plays a big part. The FSA are advocating illustrative rates of 4%, 6% and 8% at the moment. Taking the middle rate would leave you with a final pot of around £200,000. This is in real terms, as we are assuming these rate of returns take inflation into account.

Do you think £200,000 is enough to retire on? It translates into an annuity income of about £10,000 a year, a long way below the average annual earnings figure. This shortfall is so large, we can say without too much doubt that most people are deluding themselves about the level of their pensions. Even if you use the top rate of 8% growth a year, the picture is not too much better. The final sum rises to around £320,000. And remember that three-quarters of people are contributing less than 7% into their pension.

Index those pensions baby!

Barclays go on to investigate the level of knowledge and faith in index tracking as a pension strategy. That is hardly surprising considering that they are the largest manager of index funds in the world. Two-thirds thought, after a little prompting, that indexation was a suitable strategy to follow. Almost four-fifths would like the option of indexing if they were entering a pension scheme today. That is far more encouraging. Indexation is a lot cheaper and lot more consistent in its returns, especially over the sort of long-term periods that pensions tend to cover. Disappointingly, only 13% thought they were offered an index fund when they entered their scheme.

So what should you do? If you have pension, make sure you are not one of those who don't know how much it is worth or how it is performing. Start plugging those numbers into the compound interest calculator and pester your provider for some up-to-date information. An informed Fool is a happy Fool.

Related Links

• Compound Interest Calculator
• Fool's Guide to Pensions