Financial crisis and pensions
by Dr. Ros Altmann
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The Government’s emergency policy measures to guarantee bank deposits and recapitalize the major banks, will hopefully prevent a 1930’s-style depression and are obviously, therefore, welcome short-term. However, the rescue package has worrying longer-term implications, particularly for pensions.
Even before the recent turmoil, successive scandals, large deficits and market volatility, coupled with rising consumer and corporate debt had undermined confidence in pensions. As pension funds normally invest in the stock market, recent market falls have substantially reduced most scheme’s assets.
Only public sector final salary schemes should be unaffected, because taxpayers guarantee future pensions, whatever happens to markets. Private sector final salary schemes, however, have big deficits after the stock markets collapse. Employers have to make up these shortfalls, but a recession and falling profits could make this impossible for many companies. If the employer goes bust, members are covered by the Pension Protection Fund, but this only replaces 90% of expected pensions at most.
Members of occupational money purchase schemes, or personal and stakeholder pensions, will be worst affected, particularly those closest to retirement. These pension schemes do not promise any level of pension – the income they provide depends on the value of the investments and annuity prices at retirement. Most pension funds have fallen sharply, estimates suggest by around 20%, implying much lower pensions than expected only a few months ago.
Although they receive tax relief, the problem with pensions is that once money has gone in, it cannot be taken out before retirement, even if desperately needed. Pensions are a ‘locked box’, investing money until later life, unlike bank deposits which can be spent immediately.
My concern is that the Government’s 100% rescue of retail deposits in Icelandic banks, even above the £50,000 limit, suggests all bank or building society deposits will be similarly protected, so cash is now much safer than pensions. If your employer or pension company fails, the maximum protection is 90% up to a capped amount.
The emergency measures have, therefore, introduced potentially serious disincentives to pension contributions. Not only will people fear losing money on their investments, their pension savings are far less protected than just leaving their money in the bank.
These measures may, therefore, have negative unintended consequences that could further damage pensions, once people realize that pension funds are now much less protected than bank accounts. In a rapidly ageing population, that could prove extremely unwise.