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.

Nope.

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.