Gordon Brown to Raid Pensions (again)?

In one of his first acts as Chancellor, Gordon Brown raided the UK pension funds. Now as John Redwood MP points out, this might be happening again. 

Just Posted to John Redwood’s blog in response to this comment on 8th December

 

There is something else to be worried about pensions. With the government forcing down real interest rates, the returns on pensions will also go down. That is the pot accumulated to retirement will be much less (due to compound interest) and the returns that the annuity will give will be much less.

 

Those pension funds holding bonds will get a one-off boost every time the interest rates go down, but the impact of pension funds having to hold ever-larger quantities of their funds in near zero-return assets will create the following problems.

1) The pension deficits will balloon, just as companies see operating profits plunge with the recession. The government will have to nationalize the pension funds, to save the businesses.

2) Many people will try to put off retirement, just as the workforce is shrinking. The government will have to subsidize people’s pensions

3) Many financial institutions will be unable to meet existing annuity payments (if those funds are affected), so may offload this onto new annuity quotes, or ask the government to bail them out.

 

The general thinking that we should be lowering interest rates to near zero should be re-visited. With plunging house prices, and the prospect of losing their jobs, folks are not going to buy houses, or incur more debt at the moment. You are right, Mr Redwood in saying that we should reverse the VAT reduction early. However, along with a few spending cuts, this may be much too little, too late.

 

I would like to substantiate this view with a quick calculation.

How much will annuity rates be affected if the average return was changed. I did a quick spreadsheet calculation, looking at the annuity rates for a £100,000 lump sum for different rates of return.

 

I came up with this table.

 

    Return % Annuity % Income £
    1% 3.29% 3,287
    2% 3.71% 3,708
    3% 4.16% 4,159
    4% 4.64% 4,637
    5% 5.14% 5,142
    6% 5.67% 5,673
    7% 6.23% 6,226
    8% 6.80% 6,801

 

 

   

     The assumptions are listed below, but the basic point that I want to illustrate is that if the average long-term rate of return diminishes, then so will the average payout from the annuity. (The returns do not decrease as quickly, as an annuity eats up some of the capital each year.) If the weighting of lower-yielding, secure bonds is increased and the yield on the new bonds is decreased, then returns on annuities will decrease alarmingly.

In the long-term, if interest rates then go up after a few years of low rates and increasing proportions of bonds to equities, then the value of the pension funds will drop with the fall in bond values. This will more than offset the short-term boost that they got when the interest rates fell.

 

   The old fashioned method of resorting to the printing presses will come none too quick. According to Guido Fawkes the government is already laying the ground for this eventuality.

 

 

The assumptions are

1)     25 year assumed span.

2)     One payment annually and one fixed return at end of the year.

3)     Rate of return is constant.

4)     Income rises by 3% per year.

5)     Management fee of £200 rising by 3% per year.

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