It is not often that laws are presented which enjoy the support of both the government and the opposition, employers and trade unions. Yet that is what will happen when Her Majesty the Queen announces to Parliament that the government will bring forward new legislation which could be the cornerstone of better pensions in Britain.
The measure is a simple one; that Britons will be allowed to invest collectively for their retirement, just as the Dutch and the Danes are able to do. But its effect, over time could be huge. Because research shows that, after 25 years of saving, a collective pension will give a 30% higher income than a pension saved individually. Given that we set aside 6.5% of the GDP each year for private pensions, a 30% increase in productivity is nearly equivalent in value to the contribution made by North Sea oil.
It is not rocket science why collective pensions are better. As anyone who has taken an introductory finance course knows, the way to address the problem of risk is to diversify. So we buy a portfolio of many securities if we want to limit our risk. Similarly we can diversify our liabilities; for example when we buy insurance. So each of us gives some money to the insurance company, and by pooling those contributions there is enough to compensate us should our house burn down.
The same is true if you save for a pension. If you save on your own, you don’t know how long you will live for so you can’t tell how much you need to set aside; you don’t know what return you will get, or how much your pension pot will be worth on the day you retire.
That is why, until the budget, everyone saving for a pension in the UK, had to buy an annuity which ensured they had an income for life. But annuities are very expensive. And if you don’t buy an annuity you can’t guarantee you will have an income until you die.
The better way is to save together. And from the pot of money which has been saved, to pay affordable pensions. That avoids the cost of annuities. It avoids the need to cash all your pension pot in on a single day, or to save very conservatively in the last years before retirement, so you know what the size of the pot will be. That is why studies show that, in the UK, collective pensions give 30% better outcomes than individual ones.
But we must also beware that collective savings are not some holy grail. They need to be properly managed if they are to work properly. So, for example, if returns head south, it may be necessary to cut pensions in payment. In Holland, in response to the financial crisis, pensions in payment were cut, on average, by 2%. But given that they would have started 30% higher than the equivalent British pension, that is surely a price worth paying.
And collective pensions must be run by trustee bodies, whose only interest is the beneficiaries. Otherwise the temptation to misuse funds is all too great. It was that which proved the downfall of the “with-profits” funds offered by insurance companies.
But for 70 years, collective pensions have been the backbone of the Dutch pension system, regarded by most as one of the very best in the world. And the legislation Her Majesty will announce will mean that British people will also have access to a more effective pension system.