The Pensions myth
Sep. 13th, 2011 03:09 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksOne programme on the radio that I rarely listen to is Moneybox, because I feel that the quality of understanding that it brings to finance is on a par with Dick Cheney’s understanding of the American Constitution. Moneybox is like the personal finance sections of newspapers – put together with news values more based on "consumer interest" than actually getting to the heart of the matter. Nothing wrong with tabloid financial journalism, of course, but it just isn't for me. One half expects Anne Robinson to pop up as a presenter, because the style is closer to Watchdog than it is to what I see as real financial reporting.
However, I still encountered Moneybox presenter Paul Lewis, who was brought in by BBC News on Sunday morning to give his considered opinion on pensions and annuities. After rolling out some numbers that showed how drastically the returns on annuities have fallen in the past 15 years (although the most horrific number he gave was that the average saving on retirement is only about £40,000 – a sum that would currently buy you £26 a week index-linked if you retire at 65) he repeated the standard group-think that this showed how important it was to start saving for a pension as soon as possible.
Synchronistically, Merryn Somerset-Webb, someone who is not afraid to flout the conventional wisdom, pointed out in the weekend FT that this theory is probably wrong. Why? Simply because, assuming that you start work at 21, from the age of 21 to about 35, it’s far more efficient in terms of life EV to spend your money than to put it into a pension that you might not even live to collect. It makes no sense to give up 80% of your discretionary spending when in your 20s so that you increase that discretionary spending by 50% when you get to retirement age. All that this does is exchange a lot of misery now for a bit more happiness later on.
And all of this ignores the fact that there’s a solid argument for spending money while you have it, because deferring gratification now for gratification later on is intrinsically something of a gamble. First, you are punting that you will live to enjoy that later gratification. Second, you are assuming that the gratification you are giving up now will be repaid (with interest) when you are older. For a number of reasons, the odds are actually against this rather than in favour of it. Inflation may work to penalize savers and reward borrowers. Your pension provider might go bust. The tax regime may change to penalize your thriftiness. And, finally, the current system is such that if you spend everything you earn, the government will pay you more when you get old than if you save money.
Even the much-touted “tax-break” in pension saving is nothing of the kind. It’s actually just a tax-deferral. Admittedly if it serves to even out your tax-payments (i.e., keeping you out of the upper tax-bracket when you are earning, or not pushing you into any tax bracket when you retire) then you are better off. But if you are paying the standard rate no matter what when you are saving for your pension, and if your income is into the standard rate when you retire, you are no better off at all.
I was pondering all of this as I looked at the 4.5% inflation figures this morning. The Bank of England continues to say that inflation will fall back over the next couple of years, but I have my doubts. The BoE line is that the current level of high inflation relative to the 2% target is nothing to do with being demand-led or wage-push; it’s because clothing, energy and commodities are getting pricier. What the BoE misses is that after a certain period of time when inflation is at this level (and we are approaching that point soon, I think), wage-push begins to kick in. The counter-argument to this is that there is a surplus of labour and that it’s not like the old union days when organized workers had pricing power.
I think that both of these arguments are flawed. First, even if there is a surplus of labour, when the kids and the wife and a pint of beer and a football match are all costing more, the employee gets to the point where the pressures to ask for more money outweigh the rational knowledge that there is a labour surplus. He (or she) still asks for more money, or is more willing to move to a job that is offering more money.
Second, although union pricing power has fallen, look at it from the employers’ point of view. There is still a shortage of the right kind of labour, and it’s a lot cheaper to pay a 5% pay rise than it is to find a replacement for a useful and competent employee. And finding new employees of the right level of competence is not cheap. You’d probably end up having to pay what the old employee was asking for anyway.
In other words, I see wage-push inflation (resulting in a new kind of cost-inflation for suppliers) taking over just as the commodities inflation dies away.
This continues to be baddish news for savers, in that real interest rates are likely to be negative for a good three or four years, possibly longer. As I’ve written before, the battle for “who pays” for the profligacy of the past decade has already been won. The savers will pay a far higher proportion than will the people who caused it – the borrowers (stop blaming the fucking banks, for Christ’s sake; no-one in the UK was strong-armed into borrowing the cash. They went in there saying Gimme Gimme Gimme.
Oh, and Paul Lewis really does have a marvellous haircut – something like a cross between Einstein and an arts professor.
++++++++++++
PS: Angela Merkel went on German radio this morning to allay Greek debt fears.
Market responded promptly by pushing up yields on Greek 10-year bonds to 24% a year. The key wrod there was surely "uncontrolled", followed by the admission that there wasn't actually any procedure in place for the option that was not rulled out, a controlled insolvency.
Meanwhile the ECB is in the middle of an internecine battle as the Germans are beginning to ask what Trichet is doing spending billions of euro to keep down italian and Spanish bond yields. He's tried it before (with Greece) and achieved nothing bar losing a couple of hundred billion euros down the new drachma toilet. If it failed with Greece, what on earth makes him think he can succeed with Spain and Italy?
Madness.
_____________________
However, I still encountered Moneybox presenter Paul Lewis, who was brought in by BBC News on Sunday morning to give his considered opinion on pensions and annuities. After rolling out some numbers that showed how drastically the returns on annuities have fallen in the past 15 years (although the most horrific number he gave was that the average saving on retirement is only about £40,000 – a sum that would currently buy you £26 a week index-linked if you retire at 65) he repeated the standard group-think that this showed how important it was to start saving for a pension as soon as possible.
Synchronistically, Merryn Somerset-Webb, someone who is not afraid to flout the conventional wisdom, pointed out in the weekend FT that this theory is probably wrong. Why? Simply because, assuming that you start work at 21, from the age of 21 to about 35, it’s far more efficient in terms of life EV to spend your money than to put it into a pension that you might not even live to collect. It makes no sense to give up 80% of your discretionary spending when in your 20s so that you increase that discretionary spending by 50% when you get to retirement age. All that this does is exchange a lot of misery now for a bit more happiness later on.
And all of this ignores the fact that there’s a solid argument for spending money while you have it, because deferring gratification now for gratification later on is intrinsically something of a gamble. First, you are punting that you will live to enjoy that later gratification. Second, you are assuming that the gratification you are giving up now will be repaid (with interest) when you are older. For a number of reasons, the odds are actually against this rather than in favour of it. Inflation may work to penalize savers and reward borrowers. Your pension provider might go bust. The tax regime may change to penalize your thriftiness. And, finally, the current system is such that if you spend everything you earn, the government will pay you more when you get old than if you save money.
Even the much-touted “tax-break” in pension saving is nothing of the kind. It’s actually just a tax-deferral. Admittedly if it serves to even out your tax-payments (i.e., keeping you out of the upper tax-bracket when you are earning, or not pushing you into any tax bracket when you retire) then you are better off. But if you are paying the standard rate no matter what when you are saving for your pension, and if your income is into the standard rate when you retire, you are no better off at all.
I was pondering all of this as I looked at the 4.5% inflation figures this morning. The Bank of England continues to say that inflation will fall back over the next couple of years, but I have my doubts. The BoE line is that the current level of high inflation relative to the 2% target is nothing to do with being demand-led or wage-push; it’s because clothing, energy and commodities are getting pricier. What the BoE misses is that after a certain period of time when inflation is at this level (and we are approaching that point soon, I think), wage-push begins to kick in. The counter-argument to this is that there is a surplus of labour and that it’s not like the old union days when organized workers had pricing power.
I think that both of these arguments are flawed. First, even if there is a surplus of labour, when the kids and the wife and a pint of beer and a football match are all costing more, the employee gets to the point where the pressures to ask for more money outweigh the rational knowledge that there is a labour surplus. He (or she) still asks for more money, or is more willing to move to a job that is offering more money.
Second, although union pricing power has fallen, look at it from the employers’ point of view. There is still a shortage of the right kind of labour, and it’s a lot cheaper to pay a 5% pay rise than it is to find a replacement for a useful and competent employee. And finding new employees of the right level of competence is not cheap. You’d probably end up having to pay what the old employee was asking for anyway.
In other words, I see wage-push inflation (resulting in a new kind of cost-inflation for suppliers) taking over just as the commodities inflation dies away.
This continues to be baddish news for savers, in that real interest rates are likely to be negative for a good three or four years, possibly longer. As I’ve written before, the battle for “who pays” for the profligacy of the past decade has already been won. The savers will pay a far higher proportion than will the people who caused it – the borrowers (stop blaming the fucking banks, for Christ’s sake; no-one in the UK was strong-armed into borrowing the cash. They went in there saying Gimme Gimme Gimme.
Oh, and Paul Lewis really does have a marvellous haircut – something like a cross between Einstein and an arts professor.
++++++++++++
PS: Angela Merkel went on German radio this morning to allay Greek debt fears.
"The top priority is to avoid an uncontrolled insolvency, because that would not just affect Greece, and the danger that it hits everyone - or at least several countries - is very big.
"I have made my position very clear that everything must be done to keep the eurozone together politically. Because we would soon have a domino effect".
Market responded promptly by pushing up yields on Greek 10-year bonds to 24% a year. The key wrod there was surely "uncontrolled", followed by the admission that there wasn't actually any procedure in place for the option that was not rulled out, a controlled insolvency.
Meanwhile the ECB is in the middle of an internecine battle as the Germans are beginning to ask what Trichet is doing spending billions of euro to keep down italian and Spanish bond yields. He's tried it before (with Greece) and achieved nothing bar losing a couple of hundred billion euros down the new drachma toilet. If it failed with Greece, what on earth makes him think he can succeed with Spain and Italy?
Madness.
_____________________
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A marvellous haircut for radio
Date: 2011-09-13 10:12 pm (UTC)Pensions are, in a way, yet one more bubble that the current financial system has to deal with. There were a few warning shots across the bow, what with Equitable Life and all, but I don't think anybody has yet come to terms with the yield curves, as it were.
As far as I can see, they are all notional, they are all based on historical data, they are all wide open to governmental or other interference, and basically your pension is almost the definition of "fiat." As, I believe, you say here.
Savers vs Borrowers
Date: 2011-09-13 10:29 pm (UTC)Anyone with unsecured debt is pretty much being walloped by the banks at the moment as they crank interest rate differences to ridiculous levels on personal loans and rate-jacking credit cards whilst limiting transfers.
I would say that those paying the most (proportionately) are going to be anyone with (just about) affordable unsecured debt, no savings and no mortgage.
no subject
Date: 2011-09-13 11:05 pm (UTC)A lot of these 'savings' will have come from abnormal house price inflation and appropriate downsizing. I can't bring myself to feel too sorry for the baby-boomers here.
Consumer credit is about 1/6th the size of secured personal lending but nowhere near all the secured borrowers will be winners against inflation and even against a rationalised cost of borrowing.
We are probably all losers but I think the 'savers' will not be nearly so badly off if you were to factor in 'unearned' housing market gains against a 30 year mean.
no subject
Date: 2011-09-14 01:17 pm (UTC)Clearly the borrowers v savers argument is one where there are gradations on both sides. If you take a 30-year timescale, savers aren't nearly so badly off.
I reckon that the biggest gainers in all this will be the people who bought houses and then borrowed on the increased value and then borrowed again, and then borrowed again for good luck. This isn't saving, as you seem to imply. These people are borrowers, releasing unearned equity and spending it.
A common confusion is, I think, to "forget the past". I'm not talking about the winners just "going forward". I'm talking about the winners throughout their life. So, although those who have saved from 2000 on might be better off going forward than those who borrowed and spent the lot, the gains made in the future will not compensate them for the gains made from 2000-2008 by the borrowers. If I have starved yself for a week and am left with a loaf of bread, while someone else has gorged himself on fine food for a week but now has no food left, who is the winner? I would say it is the gy who had a really good time for a week because, chances are, he will find at least half a loaf from somewhere (indeed, the saver will probably have half his loaf taxed away from him to help the man now under threat of starving).
PJ
no subject
Date: 2011-09-14 03:45 pm (UTC)Back on topic, obviously the savers vs borrowers distinction is simplistic and in most cases everyone is a bit of both at some point in time (whether they think it or not).
I wasn't really referring to the re-mortgage brigade, though they seem to be in the box seat as long as there isn't a house price crash (I still think this is possible though supply seems to be countering it at present).
Obviously it is slightly speculative but I think there is a big chunk of 'savers' who have profited substantially through being borrowers (against property) at the right time and hence in some ways this represents an alternative correction against the house market bubble.
I won't get started on taxes. Pretty sure whichever way you slice it we are all going to be paying paying paying for a while yet.
I like Paul Lewis
Date: 2011-09-14 07:39 am (UTC)But it's pensions you have wrong, certainly in two respects - tax advantages and human nature. Even if tax rates stay level and the contributor is a Basic Rate taxpayer there is still advantage here because of the tax-free lump sum. In basic sums, if a BR taxpayer puts £1,000 into a pension, it is credited with an additional £250 equating to basic rate tax relief. He ends up with £1,250 in a pension pot. The next day he retires and takes the TFLS of £312 leaving a pension pot of £938. Result? He's turned £1,000 of taxable income into £250 of tax-free income plus £938 of taxable income. Win.
Plus of course there is every likelihood that income tax rates suffered will be lower on retirement and not just from the holy grail of getting tax relief at 40% and then getting the income back, taxed at 20%. Someone who has state pension and then some kind of annuity, is not paying tax on their first £10K (ish) of income. This usually leaves a chunk of their income below the tax threshold. Someone on a state pension of £6K and an annuity of £3K is paying no tax at all on it. Even if they are above the tax threshold, the amount of tax paid on it will work out less than 20% over all.
Secondly there is the psychology aspect to personal finance. I actually love deferred gratification because it contains not just the gratifying but the anticipating of that fact. In a perverse kind of way I find being owed £10K more satisfying than having £10K in the bank. But then I recognise that I'm weird in this. What is true of everyone is that people adapt to the cirumstances that they have and if that contains a commitment to say, £100/mo into a pension in their 20's then after a short while they cease to realise that any gratification has been deferred. You work out what your income is and what your outgoings are and budget the rest. People don't pine for what they never had and the £100/mo into the pension is less begrudged than the amount taken in tax/NI.
Plus you're seeing the resulting pension income as gratification and an exchange of discretionary spending in your 20's and your 70's. For the vast majority of people their pension income is not deployed on discretionary spending but essential spending and the right balance is between decadence in your 20's and food/fuel in your 70's.
That's why getting people on a ladder of paying into a pension in their 20's is the most important part of it, not the contributions that they make. It's a lot easier to convince yourself to increase a pension payment from £100/mo to £125/mo than it is to begin to put £25/mo in. People are very stupid about money and have to be led by the nose for their own best interests sometimes.
Re: I like Paul Lewis
Date: 2011-09-14 01:35 pm (UTC)On para 2, when I look at my position it is as follows. If I put £1,000 of my wages into a pension, that sum is deducted from my gross wages, so I do not get taxed on it. Therefore my net salary is reduced by only £770. When I retire, I get that £1,000 back. I pay 23% tax on it, and so I get £770. Result, deferred taxation. No gain.
So where does your benefit come from? From the Tax Free Lump Sum. Yep, I'd forgotten about that little perk. So in effect I take £250 of the £1k as a TFLS, and only pay tax on the £750. That makes a gain for me of about £72.
In para 3 you state, also correctly, that if you use the pension to smooth out your lifetime earnings, there is also a benefit (I do mention this point, and, as you know, I'm actually practising it myself -- so here we have the unuisual case of, rather than preaching sensible actions but acting recklessly, I am preaching "reckless" actions and acting sensibly!
On para 4 we begin to part ways. I also used to like being owed money than actually having it -- until three of the counterparties didn't pay up. That made me realize that if money was owed to you, you couldn't count it at 100%.
The psychological aspect is an interesting one. You are of course right. If it never arrives in people's pockets, they don't think that they've had it.
I'm less happy about your view that for most people in retirement it's about food and fuel. The system we have is that these basic needs are (just about) provided for. So a discretionary pension is, I would claim, for the vast majority, something that allows "a little bit of comfort in my own age". In that sense, something is given up when young for something that is appreaciated when you get old. If the loss when young is less than the gain when old (psychologically, if not factually) then that's a good argument for saving for a pension.
You don't address three major points: One is that the pension system is not frictionless. People make livings out of providing pension schemes, and that money comes from the contributor. The second is that you are assuming real positive interest rates. If real interest rates are negative, the £100 a month that you start saving when young will not be worth more than the £100 you put in when you are 35. In real terms, it will be worth less. By the time you are 65, that £100 will be worth perhaps £60. That means that £60 (in terms of purchasing power) when you retire needs to be worth more than something you could have bought with £100 40 years earlier at the same level of purchasing power. This is not an idle theory. My endowment matures next year and I fully expect to get back little more than I put in. £100 means a lot less to me now than the £100 that I was putting in every month 15 years ago (I now earn about three times as much). From my point of view, it was a dumb savings move. I would have been "better off" spending it 15 years ago, when £100 really meant something to me.
Finally, there's the assumption that you will survive to enjoy it. For many people in their 20s (no dependents) you are being asked to put money aside for an uncertain future (you might not reach that age) and for a net result that will probably mean less to you than it does at the moment. Psychologically it might work, but rationally it doesn't seem to me to make much sense.
PJ
Re: I like Paul Lewis
Date: 2011-09-15 09:39 am (UTC)I have increased my spending somewhat on your advice Pete. Mostly I try to buy "do's" not "thing's". (Inflation in top of the notch TV's and such is even greater than in €.) So far this approach is working well. Thanks!
another silent reader
Aksu
Re: I like Paul Lewis
Date: 2011-09-15 05:24 pm (UTC)Yes, there's probably some self-selection in pension saving! In a way that's one reason I oppose compulsion. While it's obviously right for some people, it isn't necessarily right for everyone (and that is the conventional wisdom, that it IS right for everyone).
I used to buy "things" because my mum had/has the attitude that things last while "do's", er, don't. But now I realize that possessions and memories have equal value. I'm with you -- buy the "do's" while you are still capable of enjoying them.
Lovely to hear from you.
PJ
uk evista
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no subject
Date: 2011-09-15 10:39 pm (UTC)no subject
Date: 2011-09-16 01:37 pm (UTC)Now, was cheap credit a reaction to this? In a way, it may well have been. Democracy requires that you are voted in. Most voters are unskilled or earning below the mean wage (obviously 50% of earners make less than the median wage, but more than 50% make less than the mean wage). Generally, voters consider themselves "have nots". If real wages are falling, one way to plug this gap is to make cheap credit available. And when a bubble bursts, the easiest thing to do in a democracy is invent another bubble. That is, indeed, what happened in the US in 2000 and 2003, leading to the 2008 and now the 2012 crises.
It's with your last sentence that I have most difficulty. What happened was, as you say, the proportion earned by labour declined. Let's push your hypothesis to its logical conclusion. So they borrowed more to maintain an increasing living standard. They borrowed this from other people (indirectly, via either the printing presses or from savers). Those savers then received interest on their deferred gratification (which is what the savings represented). Those borrowers have spent what they borrowed, even though they didn't earn it (because the value of their labour had fallen). And now they can't even afford to pay the interest on the principal, let alone borrow more.
So, who has "made" the money in those years? The borrowers will say "not me, mate! Make those guys who I've been paying interest pay! They are the ones that benefited!", while the savers will say "look, they've been going on their foreign holidays on money that I lent them, and now they don't want to pay back even the principal. Meanwile I've scrimped and saved for a decade without so much as a single holiday, and they have the nerve to claim that it's me who is the winner!".
You could call this Greece and Germany, or saver and remortgager in the UK.
Or, perhaps, you think that the people who brokered the transfer of cash from saver to borrower (and took a fee in the process) should pay? That appears to be the TUC consensus. But really that's just a straw man to knock down. Blaming the broker is easy, but it doesn't address the real problem. It's a bit like inter-war Germany blaming "the Jews", when the real crime was the Treaty of Versailles and the French insistence that the German people pay, preferably through austerity measures (for which, see Germany and Greece today).
But all of this is moot, since, for once, I see no need or point in being judgmental on the matter. For who should pay is irrelevant. The question we have to ask is, who will pay? And it's from there that we are now seeing what an increasing number of people are at last realizing is a crisis of democracy.
PJ
Who will pay?
Date: 2011-09-16 09:34 pm (UTC)An old gag, but apposite
Date: 2011-09-20 07:45 pm (UTC)She said she wanted to be Prime Minister some day.
Both her parents, Labour supporters, were standing there, so I asked her, "If you were Prime Minister what would be the first thing you would do?"
She replied, "I'd give food and houses to all the homeless people."
Her parents beamed, and said, "Welcome to the Labour Party!"
"Wow...what a worthy goal!" I told her.
I continued, "But you don't have to wait until you're Prime Minister to do that. You can come over to my house, mow the lawn, pull weeds, sweep my drive and I'll pay you £25.
Then I'll take you over to the shop where the homeless guy sits outside. You can give him the £25 to use toward food."
She thought that over for a few seconds, then she looked me straight in the eye and asked, "Why doesn't the homeless guy come over and do the work and you can just pay him the £25?"
I smiled and said, "Welcome to the Conservative Party."
Her parents still aren't speaking to me...........