Archive for ‘Pensions’
Gearing in the NEST
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I’ve spent time in the past lambasting the chattering classes of the industry of which I am a reluctant member (but only in the way that Karl Marx was middle class). We are those who love to muse from on high about how “ordinary” people think when it comes to finances and have lofty opinions about what they should and should not be doing with their lives.
This class controls every part of the industry from practitioners, regulators and the media and can (in my view) often be responsible for making the industry totally inaccessible for the very “ordinary” people that they so profess to care about. It’s all very Mary Antoinette to me, but hopefully with a happier ending.
The trouble with the chattering classes is they often end up creating polices designed to make themselves feel better about the world on paper, in practice wreak havoc in the long run. I guess mathematically you could refer to it as a Type II error, but it’s generally better known as the law of unintended consequences.
Recently I’ve been hearing from many of my chattering friends and associates about how terrible payday loans are. In particular wonga.com. I’ll declare a partial interest, I’m a Hearts supporter, wonga.com are our shirt sponsor and we need all the money we can get!
The conversation usually goes that these payday loan companies are nothing but modern day loan sharks. This is your first indication that anyone saying this doesn’t have a clue about the real world. It’s a perfectly fair and rational reaction to be angry and upset about the rates of interest payday loan companies charge but they don’t inhabit the violent underworld of real loan sharks! Indeed one could argue that they have at least legitimised and brought into the cold light of day a practice that has been going on for as long as currency has existed.
The chattering class abhorrence towards this product finds expression in their criticism of the presentation. To them it’s all a question of further regulation or making the interest rate even MORE clear. If only “ordinary people” could understand (in the way “we” do) how bad these products were then they would never buy them. This is again displays ignorance of the issue. In my view some of the payday loan sites could teach us all a thing or two about clearly expressing the price of their financial products. I have no doubt that many payday loan customers (reluctantly) know exactly how much their loan will cost, how many 25 year interest only mortgage customers could say the same?
I’m not defending the rates of interest that payday loan companies charge or their marketing policies. Far from it. I too worry about the debt that many people are getting into with these organisations however I do recognise that this has always happened and that it’s important that we in the chattering classes ask the right question: why are these organisations doing such brisk business? So brisk in fact that they can buy up huge amounts of TV time and sponsor major footballing teams (I’m talking about Newcastle obviously).
Rather than focus on educating people as to how bad these loans are, it would be better to ask why are people so desperate that they take out these eyewateringly expensive loans.
The fact is that people use these products because, in their mind, they have no other alternative. This is a population facing exceptionally difficult economic hardship, who have not effectively seen their real income grow over 12 years (other than through the use of tax credits).
Indeed during the boom years they were the main targets for the financial services industry’s outpouring of cheap consumer credit, the stuff that our “genius” financial wizardry helped create. With the bust in credit and the pairing back of financial support from the state no wonder many people are finding it hard to get to the end of the month and reluctantly turning to financial products that the chattering classes do not approve of.
So it’s sad to see the chatterers lament from their ivory towers about the situation of the general population rather than understanding that they are mistaking desperation for ignorance. But it’s a tragedy when this ignorance (on the part of the chattering classes) ends up creating policies that make the situation so much worse.
The launch of auto-enrolment and NEST was a triumph for the chattering classes. Finally the “ignorant” population who did not know that long term saving was good for them would have it de facto enforced upon them. The whole premise of auto-enrolment and NEST is that people are too stupid and lazy to invest themselves so we’ll make them do it. Of course no one could imagine that people weren’t investing in a pension because, for example, they couldn’t afford it or they didn’t think pensions represent good value for money.
Unfortunately in the medium term I worry that the effect of auto enrollment and NEST will be to cut people’s disposable income at a time when they really cannot afford such cuts. The worst possible outcome would be that due to the additional expense of a forced pension contribution people end up taking out a payday loan to get to the end of the month. The tragic effect of this that they are funding pension contributions through a payday loan; it’s the absolute worst kind of gearing possible.
Clearly I’ve no scientific evidence that this is systematically happening (other than some anecdotal evidence from friends and colleagues) but I do worry that we in the chattering classes are on the verge of a catastrophic failure by smugly introducing a policy without understudying its real effects.
It’s not often I’ll say this but I really hope I’m wrong.
Pensions: It’s just a rich man’s world
OK, OK, OK before Stan corrects me for starting off with a masculine reference, this could easily have been titled it’s a rich woman’s world but then how would I have forced in the obvious ABBA link.
I think that following the budget’s non-event over pensions it’s time that I returned to one of my biggest gripes about the financial services industry. The question of using an ISA over a pension.
I’ve got form on this subject indeed in financial services terms it’s probably as close as I ever get to religion, but in this analogy I’m certainly viewed as the outlandish nut job preaching against orthodox thinking.
So what’s my great heresy, well simple Pensions are totally unsuitable for the vast majority of the UK population as their main means of long term savings. Pension as a first port of call for investors should be confined to the rich and wealthy, the rest of us should use an ISA first strategy.
It’s not a case of this being an unfortunate technical failure I’m convinced this is part of a grand conspiracy by the vested interests of the industry to make life and earnings easier for themselves at the expense of their clients. Furthermore it lies at the root of many of the evils abroad in the UK financial services arena such as the appalling savings gap. Thankfully I suspect these vested interests are finally beginning to break down.
The failure of the industry (and I include the FSA and the financial media in that definition) in not adopting an ISA first strategy is something that should bring great shame on us all.
I did warn you it was a religion for me!
The ISA first strategy
Ask any focus group what’s the main problem with pensions and it all boils down to locking your money away. Now clearly when it comes to long term savings locking your money away can be a good thing, but when trust in the financial sector is at an all time low (according to the CEO of the FSA), it’s a recipe for ensuring that the last thing a client will want to do is legally lock their money away for 30 years.
And yet there is a simple solution to all this – let the client invest in an ISA. At least then they know that their money isn’t locked away for 30 years, it’s portable, accessible and just as tax-free.
So what is an ISA first strategy? Simple, when it comes to saving for your retirement customers should be encouraged to use their ISA allowance first. Whilst about half of the population use their cash ISA allowance, very few people (hat tip to Scottish Widows) use their stocks and shares ISA allowance, so every year this tax allowance goes down the plughole for about 9 out of 10 of the UK population.
Before anyone from the nanny state brigade comes along to argue that the problem with this is that clients can’t be trusted not to raid their savings, well if you truly believe that then you can still set up an ISA and make access hard, complicate and financially painful for the client that you so distrust.
More importantly the nanny state school have to look at the practical consequences of their decision to legally lock up client’s money, investors are voting with their purses and wallets and just not bothering to save. I’d rather a client tried to save and dipped into those savings when times get tough, rather than not bother at all. Those who know better than the muggles would clearly prefer the latter state of affairs!
ISA first then pension (if you want to)
Let me be clear here. I’m not against pensions far from it, I just feel that the vast majority of the population are better off investing in an ISA first and then – at the time of their choosing – they can tip their ISA bucket into a pension when they are closer to retirement.
This has several beneficial effects – firstly and rather obviously by moving the money into a pension later in life it’s locked up for a much shorter period of time.
Secondly, when you move your money into pension much closer to retirement you will have a much better idea of the tax landscape at the time. For example you may be able to identify that switching to a pension will provide you with an income in retirement that will be means tested away, in those circumstances you may well be better continuing to shelter your assets in an ISA which may well not have the same issues, it’s certainly a strategy that some investors prefer.
Thirdly, and more importantly, using the ISA first strategy you can hold off investing your money into a pension until such time as you are a higher rate taxpayer. That way you will capture higher rather than basic rate tax relief.
Meaning you can be significantly better off! Indeed on current difference between basic and higher rate relief you could be up to 33% better off using a ISA first strategy. In practice it’s unlikely to be that high and tax treatment of any plan, pension or ISA depends on your individual circumstances and can change in the future, however even capturing half that amount can make all the difference between a mediocre and a comfortable retirement.
FSA rules on projections make it decidedly impractical for me to from demonstrate this with detailed numbers but it’s covered in more detail in the Telegraph article.
A x B = B x A
So why don’t clients use their ISA allowance? Some say it is because clients are terrified of the stock market (and hence a stocks and shares ISA) where they are not guaranteed to get back all of their original investment? I can understand that, especially given the market over the last decade, but the argument doesn’t hold water as these very same clients are normally investing in funds that would qualify for a stocks and shares ISA through their pension. So it can’t be risk that’s the problem.
The argument generally proceeds along the lines of “ahh but with pensions you get tax relief on your payments and the sooner you get it the more you earn”. At this point I usually lose it (the argument and my temper) and respond like Hugh Laurie playing House.
Let me be clear it’s a mathematical truism (if tax rates stay the same) that it makes no difference if you get the tax relief now or on the day before retirement. As long as you are getting tax free growth (which, other than taxes on dividends, you are in a pension and an ISA,) then you will it makes no difference when you get tax relief.
So if you use your ISA first you can have access, flexibility in retirement and you can be significantly better off. This isn’t a debate about pension versus ISA it’s game set and match to ISAs.
Locking-in
So why doesn’t the ISA first strategy prevail in the industry?
It all boils down to the same reason that I’m typing this blog on a QWERTY keyboard – Ken Arrow’s first mover advanatge. The current layout of a standard western keyboard is not the most efficient. The most commonly used letters (the vowels for instance) are not exactly placed in the ideal spots for speedy typing. However we tolerate this inefficiency as we are locked-in to the QWERTY method of typing and no one can be bothered to learn how to type all over again, even though in the long run it will make us faster and better at putting words on screen.
So too it is with the financial services industry. Pensions have been locked-in to life company and pension provider’s systems. After A-day in 2006 when the ISA first strategy effectively became unanswerable, the cost and effort involved in switching from pension to ISA first became a difficult business case for an organisation to justify.
Surely with such intransigence from the industry we could rely on the independent advice sector to pull the providers into an ISA first strategy. It was after all clearly in their client’s best interests? But no: There was silence.
The commission conspiracy
I’ve heard the answer that advisers were not interested in the ISA first strategy because it was too complicated. Please, are you telling me that pensions are simple! More importantly guiding a client through complication towards their best interest is what an adviser is paid for!
No, there is something else going on here. Pension first survived because it locks the client into their plan, and with a lock-in comes upfront commission to the adviser. You can’t go paying out large amounts of upfront commission if the client might just up a leave the next day. The latter is quite possible with an ISA, but a pension, that’s a different story it’s much stickier and less likely to move.
So the industry has locked itself in to a pension first strategy, at the financial expense of investors themselves, for entirely self-serving reasons.
The media were sold a pass by their own admirable need to offer balance to any story, especially one that bucked conventional thinking. So when looking at the ISA first strategy they would get a range of opinions from advisers and providers who, remarkably, would all give the same answer and pour cold water on the idea, it wasn’t balance they were getting but a common vested interest.
How the regulators tolerated this I really don’t know. The Financial Service Authority brought in RU65 to rightly force advisers to justify if they were not recommending a stakeholder pension, but where was the equivalent requirement to justify an ISA as opposed to a pension?
But let’s be thankful for the abolition of commission for financial advice, that at least will break the unholy alignment of interests between the providers and advisers. And as if by magic the industry is suddenly warming to the idea of an ISA first strategy – now called a corporate wrap. There’s no legislative change in favour of ISA first but the end of commission is breaking the unholy alliance that kept clients locked in to pensions unnecessarily.
ISA first, at last
With these commission changes in place I’m quite confident (short of another fundamental change in tax legislation) that in 10 years time the ISA first strategy will be the most common way of saving and investing for retirement. Pensions will still be used but they will be used strategically and generally only in later life.
I always thought my tombstone would have “ISAs are better than pensions” carved into it, i’m hoping that soon I’ll be able to upgrade to “I told you so.”
A blast from the past
I’ve been doing some research on NEST before posting some detailed thoughts on why I think its going to face trouble and I stumbled upon an old article by myself from 2004. I think I was more surprised by the reference to Newt Gingrich back then seeing as he’s running for office again!
Anyway I was taken, with the benefit of hindsight, with some of the predictions and some of the policies I was advocating back then. Some of the predictions I got spot on, but for completely wrong reasons so I can’t take any credit for them.
Interestingly though I did warn that one of the biggest issues we faces was a generation retiring in debt – and that looks like it has very much come to pass.
The policy I did fundamentally believe in then was that pension contributions of some description had to be compulsory if we were not to face a serious crisis in retirement.
So my view of NEST is simple it’s too little, too late and lacks the courage and leadership that we so desperately need on this issue. It’s compulsory pensions “lite” when we need the full fat edition and 10 years too late.
Anyway here is the article in full – a quick word of thanks to my old friend Dewi John (the editor of Investment Adviser at the time) for coming up with the title!
What economic legacy will follow as the baby boomers move to retirement?
By Neil Lovatt. Published Aug 03, 2004 in Investment Adviser
Articles about the baby boomer generation generally talk of the hope that this generation has brought to the world and their continued positive contribution to our collective future. This is not one of those articles.
The progeny of the baby boomers were dubbed Generation X by Douglas Copeland as the title to his brilliant novel. The book opens with a young member of Generation X vandalising an Oldsmobile – the ultimate expensive sports utility vehicle – with a bumper sticker: “We are spending our children’s inheritance”.
The financial services industry still clings to the notion that the baby boomers will be the saviours of us all. It is all wishful thinking.
Psychologically, there is nothing unexpected in this widely held assumption; the vast majority of managers and executives in the financial services industry are baby boomers, and it is typical of this generation to hold themselves up as the ultimate solution to the world’s ills.
This arrogance is not symptomatic of some great failing unique to this generation, it is only the manifestation of a collective self confidence which affects any group which represents such a dominant majority.
One can see the impact of the baby boomer population, but their big failing was that they did not reproduce. From the orgy of post war copulation that spawned them, something unprecedented in the history of humanity occurred. The growth rate in the population began slowing, quite natural after such an artificially created boom, but it kept on falling and is now well belowreplacement levels – that is, 2.1 children are required to replace their mother and father. The implications of all these changes are immense and they are not all that positive.
As the baby boomers pass their most economically productive years, the economy faces a crunch point. Either an economically and politically impossible increase in taxes or a rise in savings and investment. Hence the misplaced confidence that everything will eventually come good for the financial services industry. But how confident can we really be that the baby boomer generation will not simply dump their problems onto their smaller numbered successors, Generation X?
American indications
Being ahead of the baby boomer cycle, the US gives us some interesting pointers to generational conflict in our future. The political power of the boomers in the US is so strong that even the tax cutting congress of Newt Gingridge did very little to attack the huge range of benefits and allowances which are unfairly skewed towards older Americans.
A slightly disturbing development has been the advent of elderly-only communities in the “sunbelt”, openly advertising the fact that their taxes are lower because they do not have to pay for any schools.
State support in the UK will all depend on the government in, say, 2020 when the boomers are a dominant political force. So one could argue that the boomers have an alternative solution: do nothing, do not bother saving for retirement and then, when the time comes, they know they will be a significant – if not controlling – political constituency amongst the electorate, at which point they simply vote themselves huge increases in benefits.
Even worse, what happens when the boomers begin to dis-save the assets that they have set aside? The boom that they are attributed with creating in financial assets on the way up could be nothing compared to the crash they could cause. The political effect would be a huge wave of anger and revulsion which could easily turn into a forceful backlash demanding an increase in state support and benefits to compensate.
Far from waking up to the dangers, boomers are arguably going in the wrong direction; witness the explosion in government and personal debt. Before meaningful savings can take place, these debts have to be repaid. With the clock ticking away, the boomers face a mountain to climb in terms of provision and over the last few years they have been digging rather than advancing.
Compulsory savings do not represent a constraint on people’s freedom – far from it. They are the only way of ensuring a fair and equitable distribution of wealth across generations. The question is simple: you can have compulsory savings on the majority now, or you will have compulsory taxation of a minority later.
Throughout history every generational cycle has brought a new wave of fresh thinking and new ideas to politics, culture and to the economy, but now we face stagnation as one generation dominates from counter culture into old age. It is by no means clear that the baby boomers will act their age and face up to their personal responsibilities. We should not rely or depend on them waking up; something more drastic has to happen.
This is the generation which hoped they died before they got old; well, they are reaching retirement age now, did anyone ask Roger Daltrey if he had a plan B?
Let them eat cake
OK first things first, before the comments section (if one existed) is littered with people correcting the title of this article. Of course, the actual phrase used was “Let them eat brioche” and it wasn’t, as often assumed, uttered by Marie Antoinette. It was in fact ascribed to a mythical princess by Jean-Jacque Rousseau whose major work The Social Contract is still highly relevant today.
Still the phrase is at least well understood these days as a shorthand for an out of touch elite suggesting solutions that belie a complete misunderstanding of the real world.
That’s my view of the financial services industry.
It applies to all the actors; providers, advisers, regulators and indeed the media. The brand value of the financial services industry is about as low as you can get without entering politics or tabloid journalism. And we deserve it. All of us.
We’ve lived with scandal after scandal and seem to respond to each and every one with a terrible wringing of hands and a new set of regulations which only widens the gaping chasm that exists between ourselves as an industry and our potential clients.
It’s no good the industry, a company or any adviser producing a list of customer satisfaction ratings as a way of disproving this theory. That’s just the worst kind of selection bias. It’s the people that don’t engage with the industry (who by definition cannot be clients) that should shame us.
Indeed the fact that the government (don’t get me started on them!) has instigated the de facto nationalisation of the group pensions industry, coupled with soft compulsory pension contributions on a highly unwilling public through the National Employers Pension Trust (NEST), is a tombstone of our failure.
But worse, NEST is exactly the sort of chattering classes solution to the serious problem of people’s general reluctance to invest for the future through a pension:
“The people are starved of investments they have any confidence in ma’am”
“Then let them compulsorily opt-in to NEST my good man”
Time will tell but a key statistic to watch over the coming months is the opt out rate from NEST. Within 12 months I suspect it could be over a third – the danger is of course that it reaches a critical mass when the whole thing implodes. But more, much, much more, on that later.
Let me be very clear here – I’m not setting myself up as the industry man of the people, who can personally bridge the valley between “real people” and the financial services industry. I don’t know how “ordinary people” think about financial services, I’m so out of touch I have to pay amarketing agency to tell me. I have to be tied to a chair and held down (and no I don’t like it) whilst I watch behind a one way glass with increasing frustration as my first draft marketing copy is torn to pieces, by members of the public who form a focus group on the other side of the glass, as being intellectual and inaccessible. It’s a humbling experience, but it means that the second and third draft of the copy improves dramatically, but we need a lot more humility in this industry – all of us.
We’ve got a long way to go to earn the trust of our existing and potential customers in the future. But they say the first stage to fixing a problem is admitting you have got one.
So… My name is Neil Lovatt and I’ve acted like a princess telling the masses to eat brioche. I will get better.