Why it pays to be negative about your pension

Neil Faulkner
by Lovemoney Staff Neil Faulkner on 13 November 2012  |  Comments 13 comments

As the FSA forces pension projections down, we look at why this is a good move and how to boost your own pension prospects.

Why it pays to be negative about your pension

After a long period of research and reflection, the Financial Services Authority (FSA) has decided that pension companies must lower the projections they show customers. These projections tell pension savers how much their pots might grow over 10-15 years.

Pension providers must show three headline projections, representing a poor-case, an intermediate-case and a best-case scenario. Currently, the lower projection is 5%, the medium one is 7% and the top one is 9%.

Although these numbers might seem low to you, at the medium rate, £10,000 invested today would turn into £55,000 after 25 years.

Providers have an inordinately long time – until April 2014 – to lower their projections to the new rates of 2%, 5% and 8%.

Current and new pension projection rates

Projection rates

Lower rate

Medium rate

Upper rate

Current projection rates

5%

7%

9%

New projection rates

2%

5%

8%

If you achieve the new medium rate over 25 years, you would turn your pot into less than £35,000.

These projections are not lowered to take inflation into account. Nor do they take into account any costs that apply to your specific pension plan, or any future costs, such as those you'll incur when you start taking a retirement income from it. So in reality you could expect considerably less if these projections were to come true.

Too late, too much, or just right?

It's interesting to see the different opinions about these projection changes.

The Investor, who writes a mean investment blog on the Monevator website, takes the view that the FSA is closing the stable door after it has bolted, and he believes shares are due a very big run.

The regulator, he says, has rolled up shortly after a decade or two of poor returns to warn us to temper our expectations: “As far as useful advice goes, this is a bit like Eva Braun showing up in London in the middle of the Blitz to warn Churchill that her boyfriend seems somewhat obsessed with guns.”

He goes on to ask where the regulator's warning was back in the dotcom bubble, when companies were selling for a massively inflated 30 times their earnings, on average.

You might even lose money

It's unsurprising that pension provider LV=, complains that the reductions have gone too far.

John Perks is the retirement solutions managing director at LV=, heading up the product development and sales of pensions and other retirement products. He said that LV= is particularly disappointed by the lower projection reducing from 5% to 2%.

He says: “The adoption of this rate will mean that many investments show very low returns or even a loss, deterring many clients from saving, not just into pensions but through many other vehicles.”

If I didn't already believe that a great many people do lose money on pensions, that would be quite shocking. At 2%, after inflation and deceptively high pension costs, it could easily be argued you'd have been better off putting your pension contributions in a Cash ISA, or even spending it immediately.

Perks' statement is particularly astounding since, in my opinion, pension providers don't always seem to deduct anything like enough when they move on from the headline projections to show you your personalised projected real returns. These are supposed to deduct the cost of inflation and the hefty chunk they take for themselves in fees from your forecast, and give you a realistic idea of what your pot might grow to in pound terms.

As the regulator has found, pension providers also don't always reduce the three headline projections when it becomes clear they won't be met. The FSA is planning to strengthen regulation to enforce this better.

I expect that pension providers will be racking their brains between now and 2014 about how they can make your personalised projection look better to ameliorate the effect of the FSA's new lowered headline projection rates.

Reality at last

One campaigner who truly deserves both the title “pensions expert” and “consumer champion” is Ros Altmann, who is currently director-general of Saga, making her the lead spokesperson and a major influence on Saga policy as well as pensions in general.

She sums the changes up nicely: “Better late than never – the regulator finally forces some semblance of reality on pension forecasts.”

She takes the view that the projections will be “based on lower – and more realistic – investment return assumptions of 2%, 5% and 7%, which are likely to be closer to what markets will deliver.”

You can improve your own forecasts

I don't know if those projections for the next 10-15 years are more realistic as Altman says, but it's sensible to have conservative projections at all times, since the future is so uncertain – especially with your own specific pension pot.

Luckily, these headline projections are based on average returns not just for investing in shares, but for investing in government and corporate debt (called gilts and bonds respectively), and property as well. Since some of these assets don't usually do well in the long run, this pulls down the projection rates.

You could choose not to invest in most of those, however. Generally speaking, we should expect shares to perform best over the long run, which means that, on average, someone investing largely or wholly in shares will normally do better than someone investing in other assets.

After all, it's companies that produce almost all the economic growth over-and-above inflation (whereas governments seem to do their best to create inflation and destroy growth).

Unless you think there will be no companies left in 15 years' time, it generally makes sense to invest steadily and cheaply in a large number of them to have the best chance of partaking in this growth.

Regularly contributing money to cheap tracker funds across approximately eight countries, preferably staying mostly clear from the more corrupt or politically unstable countries, is a good way to take advantage of shares' growth without giving too much of your money to the financial industry, while massively limiting the chances of making after-inflation losses.

While you probably will end up looking back at the projections as complete nonsense, you should hopefully then find that you have got ahead of inflation and grown your pot of money.

More on retirement:

20 reasons pensions go wrong

How Zopa beats the stock market

Saving in a pension? You're as well off on benefits

Why women make better investors

Two simple ways to invest better in shares

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Comments (13)

  • Getshutofgordon
    Love rating 8
    Getshutofgordon said

    If I knew then what I know now I wouldn't have put a single penny in a pension (apart from those that employers contribute).

    I am now exploring drawing my pension early and face the following:

    Annuity rates are rubbish (offered £3,300 annual pension on £75k after cash take).

    Drawdown charges are extortionate on a pot of this size

    Government actuator is and will continue to reduce the amount that can be taken because government are scared stiff people will run out of money and they will have to foot the bill.

    I am definitely not going to hand £75k over to greedy dodgy insurance companies for them to pocket if I drop dead in 5 years time!

    Seems to me therefore the best way is to draw as soon as you are able and if still working save the pension payments, put in ISA's so it gives you tax free earnings when you do retire.

    At least then you can get the maximum value from your pension before you die and minimise the effect of the actuaries restrictions.

    I am 60 and am going to do just that.

    Question: would pensions be in the state they are if Greedy Gordon hadn't raided them. When is he going to be called to account for the carnage he caused to this countries finances?

    I see he has got back on another gravy train!

    Report on 14 November 2012  |  Love thisLove  3 loves
  • MK22
    Love rating 169
    MK22 said

    Please Lovemoney, can you add code that deletes any comment that mentions Gordon Brown?

    Report on 14 November 2012  |  Love thisLove  0 loves
  • MK22
    Love rating 169
    MK22 said

    I am sorry you like Ros Altman. One eminent pensions expert, truly worth of the term, called Ros a "bandwagon jumper". Seeing as pension schemes in the year to April 2012 returned at least 3% and many returned nearer 10% or more (not at liberty to divulge how I know) the new figures do seem unduly pessimistic.

    But perhaps the Regulator could now turn its attention to the ludicrously high levels of fees charged, which relate back to the days of Thatcher who instilled us all with the greed ethic. I would have thought in these days of "belt tightening" 0.5% pa should be considered a high charge.

    (Perhaps Lovemoney ought to also delete comments that mention Thatcher, not than anyone does these days, truly the forgotten villain)

    Report on 14 November 2012  |  Love thisLove  2 loves
  • nosbort
    Love rating 160
    nosbort said

    The illustration figures make no difference to the actual performance of the fund of course so this has no actual effect other than to make fewer people invest in pensions because they can see how poorly their investment could perform and not to allow vast exaggerations of potential performance to be presented as fact. All of this, however, ignores the fact that pensions are a busted flush. Gordon Brown screwed us all over and at the same time did us a favour, his raid on pension funds in 1997 destroyed all of our pensions by taking out so much in his 'technical measure' of removing the reinvestment tax relief on dividends. It sounded so innocuous that it took the financial journalists 14 years to realise that they had all been duped. The favour it did on the other hand was to warn us that no matter what the current inducements that Governments are offering, it is a really BAD idea to tie all of your retirement income up in a fund to which you have no access, over which you have no control, and from which you are not permitted to invest in a way which makes sense at the time you need to decide. In addition, as demonstrated, your funds are very accessible if HMG decides to raid them and there is nothing that you can do about it.

    Report on 14 November 2012  |  Love thisLove  3 loves
  • DP130132
    Love rating 21
    DP130132 said

    Each year my pension annuity payment DECREASES by approximately 5%, due I am told to the disappointing performance of the fund, market conditions etc.,etc., blah. blah blah.

    Each year I write asking by how much the fund manager's salary and bonus has

    decreased. I never get an answer.

    If only I had my time over again ------ .

    Report on 14 November 2012  |  Love thisLove  3 loves
  • AlanThomas
    Love rating 35
    AlanThomas said

    I could not agree more with 'nosbort' as an investor in 3 personal pensions (26 years and counting) the projections of 8 or 9 % are totally un-realistic...if they had been, I would be retired by now!

    So the new projections are to be 2-5-8 % less a very low average of 1% management fee...=...1-4-7 % forget the 7% return it never happend on my plans, you are then left with returns of between 1-4%...if your lucky

    I had a cold call from Prudential health care enquiring if I would be interested in there Private medical cover...I replied NO! I have a Prudential private pension plan...the sales caller replied 'oh' and did not go any further...ONCE BITTEN....

    Report on 14 November 2012  |  Love thisLove  0 loves
  • muira
    Love rating 30
    muira said

    drew my pension when i found out being widowed,no dependant offsprings..that if i expired no one would benefit from the saved pot..only the trustees!!!

    went reduced hours,to try and compensate for increase in income.. now paying tax on wages,savings,pension,which i will have to live to 90+ to see it back..

    then get a letter through post to tell me i have been enrolled in nest!!..well not anymore i ain't..

    what a waste of effort..get the isa topped up..keep it where you can see it and have control..seems they are going to tax lump sums as well..

    so much for the tax incentive pension saving dream

    beware men who wear suits to work,and call themselves advisors,experts,investors,bankers etc..

    and shoot ones who call themselves politicians

    Report on 14 November 2012  |  Love thisLove  0 loves
  • MK22
    Love rating 169
    MK22 said

    Nosbert, just about EVERY pensions journalist as well as everyone elsewhere in the pensions industry said that scrapping ACT was a silly idea. The fact that it took FINANCIAL journalists 14 years to realize tells you why the financial sector has taken us all for a ride............

    Report on 14 November 2012  |  Love thisLove  1 love
  • LastChip
    Love rating 92
    LastChip said

    So, the chickens are finally coming home to roost.

    When I was complaining bitterly soon after LoveMoney's launch, about the constant pushing of pensions, and of not telling the whole truth, I was virtually tarred as a nutter. All credit though, I was never censored.

    But this is now the second time I've seen an article from Mr. Faulkner pointing out a much closer to the truth fact, that except in (now) extreme financial circumstances (six figure salaries), pensions are indeed a waste of space.

    I've been bleating on about this for I don't know how long and the sooner Mr & Mrs Average salary wake up to the fact and get out of the pension trap, the better.

    Those who think they're sitting pretty (other than perhaps the gold plated government scheme and a handful of private ones), are going to get a very rude awakening. And that's not even taking into account, how the government is quietly inflating away the National Debt.

    The real worth of your pensions, 20 - 30 years down the road are going to be practically nothing. Recognise it, and do something about it, or like others here, you'll live to regret it!

    Report on 18 November 2012  |  Love thisLove  1 love
  • RMN05
    Love rating 15
    RMN05 said

    Due to their myopic tendencies and inflated egos, pensions managers will never acknowledge that they are fleecing Joe Public with their fees linked to fund values. Joe Public would have more respect if fees were a respectable level linked to positive fund outcomes.

    Joe Public are now thankfully seeing through the smoke and mirrors of pension fund management costs. The longer management fees are disproportionate to fund growth, the longer Joe Public will scorn the pension providers and the golden goose will slowly wither, so pension managers will finally reap the whirlwind of their parasitic attitudes.

    Report on 19 November 2012  |  Love thisLove  0 loves
  • tuttogallo
    Love rating 99
    tuttogallo said

    I read an online book provided by motley fool (which unfortunately I can no longer access) in which the author detailed how the fund managers take hidden fees. This together with other hidden losses ensured that the managed funds could NEVER achieve the projected returns based on historical stock market returns:

    - hidden fees

    - dealing costs (buying and selling shares)

    - survivor bias (some companies do go bust!)

    These all reduce income by an estimated 6% per annum. The so called Total Expense Ratio is nothing of the sort.

    The fund managers also rent out their shares to short sellers and pocket the fees. As the title said it really is "The City's Dirty Secret".

    The only solution is to hold and control one's own assets, using cash ISA, stocks and shares ISA and SIPP. This will be a bold step for many people and if it all goes wrong, there's noone else to blame, but it is better than being ripped off.

    Investing in any sort of managed fund (and most defined contribution pension investments are just that) is to be continuously cheated.

    Report on 22 November 2012  |  Love thisLove  0 loves
  • LMKay
    Love rating 0
    LMKay said

    I'm a 43 yr old family man. To date I've not bothered with a pension (mostly due to lack of knowledge), but instead invested in a property, which I hope to sell on retirement to provide me money to live off. But as of late I'm considering a pension. After reading the comments above, I'm best not joining a pension scheme. But if you are working for a big company that contributes equally to what you put in, is it worth joining then? However, I don't know how long I wil end up working for this company. Any views? Many thanks

    Report on 29 November 2012  |  Love thisLove  0 loves
  • RMN05
    Love rating 15
    RMN05 said

    LMKay - virtually all guidance that I have seen from non-aligned commentators strongly recommends taking up employer offered pension schemes. However, you'll need to consider if your employer's scheme is DC,"Defined contribution" or DB, "Defined Benefit". The latter will provide a pension based on a formula specifically related to final or career average salary and years of employment.

    However, the former is purely based on known contributions for however long you are employed, the total of which will then be subject to the vagaries of the performance of the invested fund and fund managers' charges, so you take the risk associated with those vagaries. Of course, your fund will be enhanced by a) contributions from HMRC (equiv to a quarter of what you will pay, or two thirds if you're on 40% tax), and b) contributions from your employer, which will soften those risks.

    Report on 29 November 2012  |  Love thisLove  0 loves

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