Sunday, 8 June 2014

Economic Myths: Pensions (various myths)

Allister Heath packed more myths, misunderstandings and downright lies into his wednesday article than usual, so let's pick out some of the worst:

"BRITONS don’t save enough. The fact that we don’t put enough money aside for a rainy day, for our retirement or to finance long-term care, is one of our great weaknesses.

That's his opinion and he's entitled to it. Fact is, the household savings rate, as officially measured, is directly inversely correlated with house prices or with house price rises; as a cheerleader for Home-Owner-Ism, it is rank hypocrisy of him to start off with this. In the good old days with rent controls, mortgage restrictions etc, housing was cheap to buy and so people could save more. Some didn't, well tough on them.

There was a time when the UK was able to boast that we had the best pensions system in Europe; those days are long gone.

That was a lie; as he himself goes on to explain...

The old structure was killed off by a series of blows: first came increasing life expectancy, and the belated realisation that final salary promises were turning out to be more expensive than originally thought. Real pay in the 1950s, 60s and 70s was actually dramatically higher than anybody realised at the time; some lucky families are still enjoying the fruits today.

Exactly, as John Band patiently explained, this is the reason for the end of final salary pensions; it had nothing to do with "Gordon Brown's pension raid" which was no such thing.

Unfortunately, this also meant that many older firms became unviable in the 1990s and 2000s; in many cases, shrinking businesses were devoured by their giant pension funds, and became primarily focused on topping them up rather than growing. Such legacy pension issues were one contributor to the demise of swathes of UK manufacturing; it also helps explain depressed levels of investment.


i) There's a good example of that; Dairy Crest, whose accrued pension liabilities were so large it ended up being effectively taken over by its pension fund.

So if the company's pensioners and employees still in the scheme are now effectively the shareholders in the company, why would they want to run it any differently than any other group of shareholders? Answer: they wouldn't. What we end up with is a kind of employee-owned business; current workers and retirees have to come to some sort of agreement as to how available income will be split up between payments for current labour and for past labour.

ii) And it was some combination of union power, Thatcherism, Home-Owner-Ism, stupid green taxes and regulations, and the stiff winds of international competition which did for manufacturing. So nope.

iii) More to the point, the amount which companies put into pension funds doesn't reduce the amount available for real investment in real productive capacity by one single penny, unless you are incurably stupid. If you factor in tax relief, it increases it:

For example, if one of our clients is thinking of buying land and buildings, our stock advice is to put the purchase price into the pension fund; the company gets 20% corporation tax relief on that up front. The fund then buys the land and buildings and rents them back to the company. In future, the company claims further corporation tax relief on the rent it pays, which the pension fund can roll up tax-free.

On the scale of large plc's, the same applies. The basic rule is that a company pension fund cannot invest in its sponsoring employer's shares or bonds (hence why the trick only works with land and buildings, natch), but if the trustees had their wits about them, they could, for example, merge all their pension funds into one (each member's rights and each employer company's obligations could be run on a separate tab, that is not difficult).

So if a member company wants to invest £1 million in new plant and machinery and also needs to pay £1 million into its pension fund, it only needs to pay once! It chips in £1 million to the collective pension fund and discreetly asks the trustees to invest £1 million in new shares to be issued by the company. The company gets its money back!

If you factor in the 20% corporation tax relief, between them, the employer and pension fund end up ahead of the game by the amount of up front tax relief on the contribution. They can secure ongoing tax relief if they issue bonds rather than shares.

But it was not just actuarial miscalculations that did for UK pensions… Gordon Brown’s tax raid on pension funds in the 1997 Budget ended up costing them tens of billions of pounds in net present value terms by slashing the dividend stream they relied on. It was a catastrophe, one of Brown’s many appalling decisions.

Outright lie, see link to John Band article above; the loss of tax relief on dividends can easily be circumvented, see above. And it was far from the worst of Gordon Brown's decisions anyway.

The good news is that after years of political vandalism policy is finally improving. The first big change was the launch of auto-enrolment, masterminded by Labour but continued by the coalition: so far, almost nine tenths of those already eligible have decided to take part, which is a huge success. By 2018, workers will pay in 4 per cent of their qualifying earnings, with employers adding in 3 per cent (this will be passed on to employees in the form of lower wages) and the government 1 per cent.

No, nothing is improving.

iv) Compulsory contributions are nought but privately collected taxes, in this instance subsidised out of public collected taxes.

v) The government will not be paying in 1 per cent at all; the government will be levying slightly higher taxes on output and employment and then handing that over to the City of London to play with.

vi) His point about lower wages is a rare moment of sanity in all this. The result of this will be that people's net incomes during their working lives will be even lower, so it will take them even longer to pay off their mortgages. Seeing as paying off a mortgage more quickly is truly "household saving", paying it off more slowly is "dissaving", further, the rate of return on the funds in your pension scheme will be lower than the interest you pay on your mortgage, so as per usual, the little guy loses out overall.

The second major breakthrough was George Osborne’s brilliant decision to abolish the crazed requirement for individuals to convert their pots to annuities, or else face a punitive tax hit. The money is now properly the savers’, to spend as they wish. To date, this has been Osborne’s most inspired move.

vii) The requirement to take an annuity at a certain age (or the tax penalty for withdrawing funds early) has been gradually watered down over the last ten or fifteen years, all Osborne did was call the time of death.

viii) We know for a fact that if people know they are going to get a pot of cash at a certain age, they will save less in the run-up period; so for example it will become quite common for people to underpay their mortgages or take out interest only mortgages and hope to pay them off with their lump sum. This is just another one of those stupid gambles which go as horribly wrong as endowment mortgages.

ix) And behind this move is the idea that pensioners will take their funds out of the productive sector (pension funds are largely invested in shares so have every interest in the businesses they have invested in doing well, see above) and spend it on land and buildings instead, thus pushing up house prices even further, thus pushing down the household saving rate even further etc.


Rich Tee said...

What strikes me about auto-enrolment is that it remove a chunk of people's disposable income, which may affect economic activity. Labour want to extend it to the low paid, who are more income sensitive and will curtail their spending more than the well-off, who might have saved it anyway. With my employer's scheme it will eventually be 5 per cent directly, but my employer has said that their 5 per cent contribution will be coming out of the "pay pot" so there will be fewer, lower pay rises. So that is effectively 10 per cent of disposable income being removed from the economy.

So we may end up with lots of pension investment money sloshing around, but declining economic activity in which it can be invested.

Lola said...

About auto-enrollment. It's a Very Bad Idea. As a clue there are 254 pages of official words you need to know with new 800 rules. Or the other way about. I forget.

Mark Wadsworth said...

Rt exactly!

L, either way it's more than 1,000!

Lola said...

MW. We have been looking at this as a new business stream. Now, that's all very well for us, but it is clearly another overhead cost for employers. Small companies do not have the HR resources to do it in house, and although they can go straight to NEST, they still need to obey all the rules, which NEST won't necessarily help with. And if the employer gets it wrong, they'll be 'fined'. On top of that it is complusion, which is fundamentally wrong in a free society. Also, pension funds may not be the best method for a particular person to use for 'long term savings'. Furthermore you and I both know that most of any tax relief given goes straight through the system into the hands of rent seekers in the heirarchy of the pensions industry and / or government taxation on pension income payments.

You may also know that the FCA and others are using the alleged new insights of 'behavioural economics' to justify these interventions. BH basically says that people make irrational decisions. The gummint and the regulators take this as an invitation to intervene, conviently forgetting that if BH is true then their interventions are also irrational (which is self evident if you spend any time reading any history at all).

Given the history of all previous pensions interventions, I am supremely confident that AE will fail.

Graeme said...

sorry for a few randon quesions:

1/ does anyone know whatever happened to the irrecoverable ACT that disappeared in the "Brown" changes?

2/"viii) We know for a fact that if people know they are going to get a pot of cash at a certain age, they will save less in the run-up period; so for example it will become quite common for people to underpay their mortgages or take out interest only mortgages and hope to pay them off with their lump sum. This is just another one of those stupid gambles which go as horribly wrong as endowment mortgages"

isn't this how the system works in Australia? if that is correct (and I hasten to say that I do not really know the facts), are there many destitute Australian pensioners?

3/"pension funds are largely invested in shares " is this still the case? I thought that they were mostly invested in gilts, since the Brown treatment in 2000-2003, which, when things got rough in 2008, encouraged the govt to go in for the QE treatment. Maybe some facts are needed. Certainly the BT and BA funds - which are truly ginormous - are mostly in gilts these days, or were when I last looked a year or 2 ago.

4/ "paying off a mortgage more quickly is truly "household saving"" you will have DBC on your back for this. He really hates the idea of households saving at the expense of some other entitiy yet to be established.

Rich Tee said...

Graeme, the AE pension offered to me offers a choice of funds, most of them invested in shares. The default fund is basically a FTSE 100 tracker.

Lola: "it is compulsion, which is fundamentally wrong in a free society". Completely agree. Although pensions are compulsory in other countries like Australia, the money is put into a non-profit public fund, not scooped up by private, profit-making insurance companies like in Britain. It is compulsion to enter into a contract which is a violation of my individual rights as far as I'm concerned.

I am furious about it. I have a SIPP which I am perfectly happy with so I was already doing what the government wants but the legislation makes no allowance for that. I have opted out but in doing that I forfeit the employer contribution. I have written to my MP Rachel Reeves who is a keen supporter of AE but after 4 months still no reply.

I am glad that people here are raising these points as nobody else will talk sensibly about this, it is just treated as automatically a "good thing".

Mark Wadsworth said...

L, just like stakeholder pensions, interest rate swaps, endowment mortgages, PPI etc. Most things which the financial sector dream up fail, apart from the mechanical stuff like debit cards and cash machines, which work incredibly well.

1. The ACT went towards cuts on the rate of corporation tax. Overall, corporation tax receipts minus refunds before the change were = corporation tax receipts after the change. People conveniently overlook.

2. I think so, but make up your own mind.

3. Some are more in gilts, so what? They can still invest in shares or corporate bonds if they want to.

4. Saving is the opposite of dis-saving or borrowing. Taking out a mortgage is borrowing therefore paying it off is saving, end of.

Mark Wadsworth said...

RT, I opted out straight away. Fuck em.

Dinero said...

are you saying it is a financial error for anyone paying interest on a mortgage to simmultaneously pay into a pension. That seems a bit of a radical statement, not heard that before.

Lola said...

MW. Stakeholder was the invention of the Blair government. Interest rate swaps, although invented by the private sector are driven by central banking failure. Endowment mortgages 'worked' for a certain class of buyers. They did not work for the vast majority of buyers. I think endowment sales were driven off the back of mortgage credit expansion by the gummint. The gummint and the regulators told us to sell PPI - another gummint failure. (FWIW we have sold about three PPI plans and one was successfully claimed on - they do work if you do it properly.) And so it goes on.

PJH said...

"BRITONS don’t save enough. The fact that we don’t put enough money aside for a rainy day, for our retirement or to finance long-term care, is one of our great weaknesses"

Well it doesn't help when we have the likes of Mr Bean telling us to spend our savings

"In unusually unguarded comments for a banker, Charlie Bean yesterday discouraged people from building up cash savings which generate little income due to historically low interest rates."

Ok - that was 2010, but the sentiment is still there.

Rich Tee said...

I like your attitude MW. My SIPP is far more flexible than my AE pension.

Dinero, there is a good argument for delaying paying into a pension until you have bought and paid for a house. This is because if you don't own a property when you retire you will pay rent out of your pension. But if you own a property outright you can live in it rent free so your pension may be smaller but you get to keep more of it for yourself.

Mark Wadsworth said...

Din, see subsequent post for the answer to that.

L, I once saw a list of financial sector misselling scandals, and it included dozens and dozens of things, some of which we have forgotten about.

PJH, excellent point, I'd forgotten about Bean.

RT< I don't know in detail, but can you not get your employer to make the "compulsory" 3% contribution to your SIPP? If you have a bit of flexibility, you should be able to wangle a 4% relative pay rise anyway, which you could then salary sacrifice into your SIPP. Or something, ask Lola.

Lola said...

MW - careful. No such thing as 'mis-selling', that's just weasel words. You are either conned or you are not. There is and can never be coercion in selling - especially where cancellation rights exist. 'Mis-selling' is a manufactured Fabian Gradualists wet dream.

Although I grant you most stuff sold by banks who allegedly 'gave advice' were, well crap. But who in their right minds ever trusted a bank?

Lola said...

Oh, and just to add, being on the inside and all, nearly all 'mis-selling' I have ever seen was in some way either triggered or as a result of some stupid government/bureaucratic failed intervention.

And a lot of 'mis-selling' just wasn't. It was a vehicle for bureaucratic expansionism, what I call bureaucratic marketing. They simply concentrated the benefits and distributed the costs.

Bayard said...

viii) The wizard wheeze now is to persuade your employer to knock you down to minimum wage in the run up to retirement and put all the remainder of your salary into your pension pot. This way you don't get to pay any NI, whilst subsisting on withdrawing from your pension pot early, as the rules now allow and only paying income tax.

ix) Wasn't that the whole point of the change?

Mark Wadsworth said...

L, the government and regulators and courts might be a bit stupid, but the banks are guilty as Hell of mis-selling. You can blame government etc for quite a bit, but how much would the banks get away with without them?

B, excellent wheezes, that's the sort of thing I do all day long.

PJH said...

Possibly relevant:

"As Ryan McMaken noted on June 5, the European Central Bank has instituted negative interest rates for member banks. This could soon spread to the US and also to consumer accounts. If so, you would find money taken out of your bank account each quarter unless you spend it. Some observers think that in the US at least it will start with higher account fees, which will be stealth negative interest rates, and then move to overtly negative rates.

The idea is that if low rates are not yet persuading you to spend, then why not punish you even more for saving. To make this more effective, there would also be a push for all electronic money, to keep you from stashing any away from the confiscation agents.