Monday, 11 March 2013

Fancy a guaranteed pension?

We all love a guarantee. It means we don't have to worry.

A guaranteed price, guaranteed weather, a guarantee that a product will work. But most of all, perhaps, guaranteed peace of mind when we retire.

A guaranteed pension. What's not to like?

That's why the pensions minister, Steve Webb has been pushing the idea of pension guarantees - and why he's likely to be asked about it when MPs interrogate him on pensions this afternoon.

He calls it Defined Ambition, but what he really means is two things:

A. Salvaging something from the wreckage of the best final salary pensions - the ones which pay a pension based on your salary when you were working and which are being closed down right, left and centre.

B. Or shoring up the inferior schemes which employers are offering instead, the ones which are little more than employer-backed savings schemes. They help you save; you cash in the savings when you retire, but take all the investment risk.

The inferior ones are what most people will get because most companies will offer these when they sign up staff for pensions automatically under the new policy of "auto-enrolment."

And adding a guarantee to them is a seductive idea.

The guarantee would be a promise that you'd get at least as much out of a scheme as you put in.

The problem is that guarantees cost money, in the form of insurance, a pooled fund, or hedging mechanism from the City. And the cost would reduce the size of your pension.

Version 1 would be simply to guarantee the cash amount of contributions, but after 20 or 30 years, that's hardly worth having - because inflation, or price rises, would eat into the guaranteed amount.

Version 2 would be to promise that you would receive at least what you put in, increased to compensate for inflation, which does sound valuable.

The pension experts at Hargeaves Lansdown say that the cost of Version 1 would be a mere 0.06% of your contributions per year.

However, that's only if you cash in your chips at a pre-set time. The cost rises to 0.39% if you want the right to take the benefit when you choose.

Version 2 would cost 0.24% if you stick to one cashing-in date (these numbers are from the OECD) but an unknown, much higher amount if you want freedom over when to start the pension.

Hargreaves says the price could rise to 1% extra a year, "far in excess of the kind of charges deemed suitable for default auto-enrolment schemes".

That's a lot when you compound it over a lifetime.

The question is whether the guarantee worth having is actually worth paying for.

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