Pensions – The Missing Factor

We are told (for instance here and here, the major reason increase in the real cost of pensions (and the consequent demise of private sector final-salary pension schemes) over the last few years are

1. The increase in life expectancy.

2. Changes to accounting rules, meaning that companies have to include future pension liabilities in their balance sheets

3. The low returns from the stockmarket since 2000 – exacerbated in the current recession.

4. In the UK the 1997 Gordon Brown tax on the investment income of pension funds.

But the biggest cause of the rise of the pension deficits is the fall the long-term real rate of interest. This not only impacts on the compound returns to the pension “pot”, but also the size of the annual annuity that can be purchased on retirement. As a consequence, a fall of just 1% in the rate of interest might increase the contributions by 50% to obtain the same size pension. Always low interest rates benefit borrowers to the disadvantage of savers. Like sub-prime, pensions are another long-term hangover from the low-interest party since 2000.

In the UK, as a consequence of the low interest rates and high government spending we now have the following problems.

EITHER – We have low interest rates, meaning those working now have to save more for retirements

OR – We have higher interest rates, meaning higher taxes to fund the ballooning national debt and a steep fall in house prices.

The short-expediency of boosting the economy by low interest rates and deficit spending has reduced living standards for the elderly in the long term.

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