The Gift Horse
By Alan Steel
For publication in Scotland on Sunday 10 November 2013
Forty one years ago a Pensions expert did his best to explain to me how Final Salary schemes worked. After an hour of trying to comprehend his technical mumbo jumbo, the penny dropped when he compared them to a water tank with a tap at the bottom. Don't ask! What is important is I said that can't possibly work. Shhh, he said, dinnae tell anybody....... And that was 15 years before all sorts of ridiculous restrictions were imposed...... Ever since I've watched in horror as poor design, deep investor and employer ignorance, actuarial smoke and mirrors, Government interference, greedy salesmen, ineffective regulators, and hidden charges have destroyed many, many thousands of retirements.
And yet for value for money a simple cost effective Pension plan is hard to beat for long term savings. Let me give an example. As you will be aware Grangemouth had its problems recently. The old BP Final Salary Scheme at Ineos is being closed. Not only doesn't it work, it could have brought down the company, something which should have been obvious forty years ago.
Workers have been offered an alternative which some wags tell them isn't a good idea. One of the workers phoned us for a chat. He, and his colleagues, had been offered instead, as he said, something to do with refined retribution..... A Defined Contribution Scheme we suggested. Aye that's it, he replied.
We dinnae fancy it he went on. I've only 10 years until I'm 60 so I'm not putting in good money after bad. His pals feel the same he said. Let's just stop and think about this we replied. You're to contribute and so will the employer. Aye he said, 6% of our income and 11% from them. Right we added, you're a 40% tax payer with an income of £50,000 a year, so you'd only contribute £1,800 net to have £8,500 invested for you. And into a plan not liable to tax on internal profits. Over ten years he puts in £18,000 to get £85,000 invested. And he doesn't think that's a good idea?
Let's assume he rejects the Gift Horse, and has the discipline to save his net £150 monthly, in a Bank Account. As a 40% taxpayer with low interest rates for a few years, at 2.5% pa - he'll have £20,000 in ten years. Even if his new pension plan returns only 5% each year, the fund will be £109,780 after costs. After he takes the tax free cash - over £7,000 more than he'd build up in Deposit - he'd be left with over £82,000 to buy an income. At current rates that's an extra Guaranteed £4,000 a year for nothing! Keep the charges down, pick decent funds and the end result's even better.
In October Neil Woodford announced he would be giving up running his two big Income type funds at Invesco Perpetual. They are popular investments held by Pension Plans. Over the last ten difficult 10 years of the so called Lost Decade his funds have made over 7.5% pa after costs. A repeat of that would create for our friend at Grangemouth, tax free cash of £31,270 and an income which right now would pay out over £4,500 a year guaranteed. In non jargon terms that's called a No Brainer. It also qualifies as a Free Lunch.
For publication in Scotland on Sunday
Sunday 10 November 2013