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Save under 30s from pensions misery with giant funds

Are UK pensions fit for young people? Katie Morley writes to the pensions minister to suggest a radical system to curb excessive industry profits and give savers bigger pensions.
November 19, 2013

Dear Steve Webb, MP,

Your pensions system is going to fail my generation and I would like to help you do something about it.

When I last brought the issue up with you in person you said we should all stop buying Sky TV packages. This suggestion was irritating at best.

Policy makers are tiptoeing around the pensions industry and their bloated profit margins. Meanwhile, financial pressures mean young people simply can't afford to lock 15 per cent of our salary into a pension for a chance of a decent retirement income - as you want us to.

Enough is enough. Yes, improvements are being made but drastic changes are what we need to solve the pensions crisis.

I am 24 years old with no formal financial training, but I have a plan to transform UK pensions for my generation. For all the impressive qualifications and vast experience of pensions experts, just look how badly defined contribution pensions are failing people today. I don't think some fresh ideas on the table would do you any harm.

My plan is designed to put people before profits to 'do more with less' and to give young people a clean slate for a brighter future.

Unfortunately, most of the pensions providers powerful enough to lobby for change are clouded by vested interests, and merely see young people as a redundant market in which there's little money to be made.

Particularly telling was a conversation I had with a senior PR manager of a major pensions provider at a press party last year. He laughed in my face when I told him about my campaigning for young people's pensions. "Do you have any idea how insignificant the under 30's share of our market is, Katie," he said.

"No one cares. So do yourself a favour. If you want to make a name for yourself as a writer, write about the baby boomers - because that's where all the money is."

Are you surprised, then, Mr Webb, that the pensions industry's disinterest in us is mutual? The world is changing fast and young people want pensions that are efficient, trustworthy and obviously relevant to their needs.

When hidden fund management fees can cream 40 per cent off a pension pot, and annuity providers then chop off a further 20 per cent at retirement - can you really blame young people for buying Sky TV packages instead?

On the basis that pensions don't (really) want us - and we don't (really) want pensions, I think under 30s (and all the generations that follow) should be removed from the system altogether and placed in a new system where they are properly valued.

Here I outline my plan to give my generation better pensions. I'd be interested to know what you think of it.

Yours sincerely,

Katie Morley

Personal finance writer

Investors Chronicle

 

A monster problem needs a monster solution

Under the new system, instead of being auto-enroled into individual workplace pension schemes as young people are today, unless they are in the public sector (in which case they get a generous gold-plated pension), they would be auto-enroled into one of a controlled number of giant funds called collective defined contribution (CDC) arrangements.

The system would allow anyone older than 30 to enrol themselves into CDCs if they want - but because some of them have very generous defined benefit arrangements in place, it seems logical to leave them in the old system with the option to leave if they like. Staging under 30s in first would also give pension companies time to adjust and phase out their old business models.

These giant funds would be transparent, friendly giants that use economies of scale to make people's money go much further. The more money they hold, the lower administration and management costs can go. Such schemes are already being used in Sweden and Denmark - countries known for providing some of the best value for money pensions in the world.

But the UK has rejected them as an idea a number of times - mainly because they have been repeatedly blocked by influential people with vested interests, who would lose business if they replaced all the small schemes that require expensive individual administration and advice.

The latest research by the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) shows these giant funds are capable of increasing the value of British people's pensions by a third.

They also deliver more reliable pension incomes than individual pensions, which are heavily dependant on fluctuating annuity rates. In Denmark, where CDC is already up and running, retirement incomes have fallen by around 2 per cent since 2008's credit crisis - but in the UK, annuity rates have fallen by over a third, according to David Pitt Watson, a former fund manager and researcher at the London Business School.

The amounts of money involved could eventually be huge. Collectively, 2.5 million workers aged 22-30 would be poised to funnel £3.6 billion into pensions every year if they were all auto-enroled - contributing an average of £1459.36 a year (8 per cent of the median salary) into pensions, as ONS data shows. Over several decades, the pot would expand to several trillion pounds in size to accommodate the retirement savings of people of all ages.

 

Who would run the monster funds?

The government would be in charge of regulating and deciding which private sector providers can run these funds. In the same way energy providers are selected in the UK, pension fund managers would compete to become one of a set number of giant market players.

Having a handful of giant funds - rather than thousands of small ones - would be much easier for the government and regulators to keep tabs on - and for the press to analyse. This would minimise the likelihood of bad practice which will restore confidence in UK pensions.

 

What would the funds invest in?

The logic behind giant funds is that pensions investment should be left up to people who are genuine experts in their field. They are actively managed funds which invest in a wide range of assets. All savers get the same assets, but the investment agenda is decided by an independent body of trustee representatives from the employers paying in the pension money.

It's "madness" to expect ordinary people to become investment gurus - as they are encouraged to do if they want to make sure they're getting the most out of workplace pensions. Many have overly cautious and overpriced default funds in which an average of 90 per cent of staff are invested - their only hope of getting a better deal is choosing their own investments.

Another advantage of giant funds is they can spend huge amounts of money funding major infrastructure projects that the UK desperately needs - such as new bridges, sewer systems and railways. This summer Prince Charles warned that the younger generations will face an "extremely miserable future" if pension schemes do not step in and invest more heavily in such long-term projects.

Aside from pension fund managers being motivated by short-term rewards, a major barrier to smaller funds investing more in infrastructure is the sheer amounts of money required. But giant funds could invest on their own, and infrastructure would be the perfect investment for them.

 

Charges

The fees people pay to have their pensions looked after would be drastically reduced in a giant fund. The government recently proposed a cap of 0.75 per cent on annual management fees - despite the fact many of the funds on offer are tracker or closet tracker funds which can be run for much less than this.

But the management fees for giant funds could easily be pushed below 0.3 per cent for a sophisticated actively managed fund - which looks like much better value - especially when you consider a 1 per cent fee can rip a third out of the value of a pension pot over the course of a working life.

In the new system the government would also force pension funds to disclose hidden fees such as trading costs. Aon Hewitt estimates these costs can add a further 1.25 per cent annual charge onto your pension - biting more than another third out of it. But if pension funds are forced to disclose all their short-term trades they are using to beat the market, they will be discouraged from using them to enhance performance figures - creating a false return for investors. In Sweden and Denmark, many of these costs are displayed in pounds and pence on an annual report for all to see - so there's no reason why we can't do the same here, other than that fund managers don't want to.

 

Retirement income

In the new system people would still have the option of buying an annuity at retirement if they want, but they will also be able to take an income direct from the giant fund, if they are able to take the risks involved with staying invested.

Another option that savers could choose is some form of guaranteed income level at retirement - similar to what the government is proposing in its defined ambition paper. This could mean they get a lesser pension pot overall, but it provides a half-way house between total stock market exposure and an annuity and therefore may be attractive to some people.

 

Where would employers fit in?

Giant funds would take the burden to provide a pension for staff away from employers. This would be particularly welcome to smaller firms without much pensions knowledge or resources. They will still be responsible for choosing which giant fund(s) they would allow their staff to go into - and instead of having to pay fees for set-up costs and administration, they can concentrate purely on making generous employer contributions. Some may even decide they will pay the annual management fees on behalf of their staff, so they can keep all their returns.

 

What are the main benefits?

■ Savers run less risk of poverty in retirement because they get significantly better pensions outcomes.

■ The system is more efficient and less prone to bad practice that can damage pension pots.

■ Ordinary savers and their employers don’t have to worry about complex investments – it’s all left down to the experts. Employers have more money to spend on pension contributions.

■ The government and regulators will find it easier to keep tabs on a small number of pension funds.

■ Confidence is restored in pensions because the system is more efficient and transparent.

■ The vast intergenerational inequality between young and old people’s pensions will be narrowed.

 

What are the main risks/problems?

■ The scheme could become underfunded. This would mean new people joining the scheme would get a worse deal than people already in the scheme.

■ Some commentators believe there is a danger that exceptionally large funds could be "read" by the market which would cause them to lose a lot of money, but others dismiss the issue as a "marginal risk".

■ If something goes wrong with one of the giant funds, millions of people will be affected and their retirement funds potentially damaged.

■ Currently, CDC is illegal in the UK.

■ Most people in the pensions industry would object to CDC because they have a vested interest in keeping the current system, even though research shows it has a worse outcome for savers.