The next pensions scandal
Pension returns could easily be over-estimated by a quarter.
Sadly we've seen a whole raft of pension scandals in recent years, from mis-selling to tax changes to income drawdown. Perhaps you'll recognise some of them in 20 reasons pensions go wrong.
I fear the next pensions scandal could be about projections - the guidance given to savers about how big their pension might be when they retire. If it isn't the next scandal, then there's a good chance it'll be the one after.
Pension providers have to make projections according to standardised figures and adjust these based on estimates of their own costs. Pension holders can usually expect an update once per year.
Unfortunately, these projections don't take into account all the costs that you'll face. This could lead to the projections overstating customers' final pension pots by a quarter or more.
What are the standard projection rates?
Pension providers are obliged to show projections at the rates set by the Financial Services Authority every few years.
For the past few years, the regulator has required that lowest projection be 5% gains per year, with , 7% and 9% being the mid and top projections, all including inflation.
Now, the FSA is in the process of reducing its projections. It's considering changing them to 2%, 5% and 8%. This still won't solve many of the problems with projections.
What's wrong with pension projections?
Aside from how confusing they are, there are some serious problems with the illustrations that pension providers give their customers.
Hidden costs of investing
The first is that, when the basic projections are modified to take costs into account, a large percentage of the costs are excluded. There are hidden costs, such as an investment fund's costs when the manager buys and sells shares.
I've seen different estimates over the years, but these hidden costs are probably between 0.8% and 1.4% per year for an average fund. That sounds low, but these extra costs could easily wipe out a quarter of your gains over decades of investing for retirement.
Simply put, if you end up with a £75,000 pot, you probably missed out on another £25,000 by paying costs that you weren't even aware of.
Hidden costs of inflation
The cost of inflation also isn't properly accounted for. Although the projections have to include some standard measure of inflation and its effects, they don't explain that you'll pay higher costs because of inflation too.
In a double-whammy, the more inflation you have to fight, the more costs and expenses you'll pay to the investment funds. This further eats into your real gains in the long run.
Pension income lottery
Your projection will also usually have a stab at telling you what retirement income you can expect, based on the same projected pension gains.
Your final income is impossible to predict with any reliability, because in the end we don't know when we will retire or how long we'll be expected to live at the time, both of which are just two of the major factors that have a massive impact on the income you'll be offered for your pension pot.
What happens when this latest scandal breaks?
Unfortunately, I doubt we'll be able to sue anyone or claim our money back like everyone's doing with the payment protection insurance scandal.
All of the pension providers will point the finger at the FSA and its rules on projections and personal illustrations, and the FSA will be long gone by then – since the regulator is once again getting a makeover, which mostly appears to involve changing its name again.
The regulator, whatever it's called at the time, will probably shrug its shoulders.
The best thing we can do is try to make our own estimates of return and constantly keep track of our progress, while keeping our investing costs as low as possible:
Make your own estimates: How much you need to save for retirement
Keep your costs down: Two simple ways to invest better in shares
Costs are important: Why most pension savers lose
Investing is still worth it, despite costs: How to get higher investment returns with lower risk