Fool's Eye View

[ September 6, 2000 ]

Scary Numbers for Pensioners

By Rob Davies (TMFEssex)

Carburton Street, London -- Foolishness covers many aspects of our financial lives and one of the most important of those is savings. One message that we really want to get across to Fools is that it is up to them to make their own provision for the future by building up a pot of their own money. That pot will be used mostly to generate an income in retirement. Of course some people aren't concerned about saving for their retirement because they have a pension.

Now, The Motley Fool has a rather ambiguous attitude to pensions. While we applaud the idea of saving over the long term, and the tax breaks and company contributions that go with them, we hate all the rules and regulations that make them so inflexible. And most of all we hate the high charges and lousy returns that pension funds deliver. That said, many people do have pensions. But in fact the data on pensions is so scary that it ought to prompt people to make their own arrangements anyway.

To illustrate the point I shall use some data I unearthed on the Internet from the Centre for Market and Public Organisations at the University of Bristol. The first table shows just how many employees have pensions.

Scheme Type       Number of people   % of working
                    (millions)      population covered

Occupational            10.5             30
Personal Pensions       10.2             29
SERPS                    7.1             20
None                     7.4             21

The fact that 30% of the population have an occupational pension might give us some comfort. But how many employees actually stay with one company for their whole career and thus qualify for a full company pension? Not many, I bet. Perhaps the fact that almost half the population has a private pension is good news? Well, not really. For a start, many of the personal pensions are so-called Appropriate Personal Pensions that mostly exist to take contracted-out SERPS contributions. They account for 5.6m people, or 16% of the working population. The remaining 4.6m, or 13% of the population, have personal pensions that are entirely self-funded. However, many of these are no longer active and have been converted into paid-up schemes. In these, the employee makes no further contributions, but the provider still extracts charges and that of course reduces the final maturity value. A survey in 1997 by the Personal Investment Authority revealed that in 1993/94 16% of personal pensions were terminated within one year and 28% within two years. So many of those personal pensions are worth diddly squat.

What is worse is that contributions to active personal pensions are actually very low.
This table comes from the ABI Insurance Statistics Yearbook for 1987-97:

Average Premium on yearly policies (£)

                  1993   1994  1995   1996   1997
PPs in Force       278   272    273    280    293
New Policies       778   901    981  1,105  1,164

While many people clearly start with good intentions, making significant contributions, a lot of them lapse and the survivors are really making very small payments. Even with very good compound returns there is no way that saving £300 a year is going to give you anything like a decent pension. Contributions to a personal pension fund are entirely at the discretion of the individual, which is why they are so small. But that is not the case with occupational schemes where wise and sagacious actuaries determine contribution rates. And we can see what they think people need to tuck away to have a half decent retirement.

Average premium per member (£)

                       1993   1994   1995   1996   1997
Defined Benefit       1,345  1,349  1,539  1,487  1,937
Defined Contribution  1,574  1,561  1,511  1,667  1,971

These guys are probably chucking in close to £2,000 a year now, compared to about 15% of that for personal pensions. It is hard to escape the conclusion that an awful lot of people in personal pensions are going to realise at some point that they really have not got very much at all in their pension fund.

So what should these underfunded aspiring pensioners do? Rely on the state pension of £67.50 a week, or do something about making meaningful savings? Fortunately, there is an easy solution. ISAs allow individual to save up to £7,000 this year, and £5,000 from next year, entirely tax-free. Compared to the contributions people make to pension funds, an ISA provides more savings capacity than most people will need. And, if you choose the right one, the cost will be a whole lot lower than that of a pension fund. While £7,000, or even £5,000, might sound like a lot of money, that is about what you pay in interest on an interest-only £100,000 mortgage. Many people don't think twice about paying that, but that money might be of more use growing nicely in a tax-free ISA.

Saving for retirement through a pension fund does have some benefits, but in fact not many people take advantage of them. ISAs provide a much lower cost and more flexible mechanism. In the end it doesn't really matter too much which route you choose, as long as you do it.

Where Next?

For more information on pensions have a look at the pensions discussion board and for ISAs take a look at our Guide to ISAs