23 Mar 2014, 7:25pm
personal finance:


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  • calling all late 40s+ wannabe early retirees – your ship’s come in…

    Martin Lewis, he of moneysavingexpert fame, considered the pension changes “both wonderful and horrid“.  Wonderful, because you now can take it all in one go subject to normal income tax rules, without all sorts of restrictions that mean you have to drip out the money over 20 years or so. And horrid – because you now can take it all in one go, so people may blow it all on this sort of thing

    That'll be a nice Lamborghini, and to hell with the money

    That’ll be a nice Lamborghini, and to hell with the money

    as the pensions minister quipped.

    Extreme wealth warning – everything to do with pensions is hard, counterintuitive and needs careful consideration

    You’re on here because you have an interest in personal finance, right? Most people consider it dull as ditchwater – indeed I only sharpened up my act when I realised that getting my skull round this would enable me to quit an increasingly toxic workplace. Before then I was happy to rock up and work, do a reasonably interesting stuff  in return for beer and toy tokens. The Grauniad delivered this quite astonishing piece by Joanna Moorhead saying

    When it comes to pensions, choice is not necessarily desirable – especially for those of us burnt by endowment mortgages

    WTF? It is precisely because I was burnt by endowment mortgages (though reinstated) that I don’t trust insurance and life companies and was grateful that in pension provision I never had to think about them. If I had to manage a DC pot I would now be deeply grateful to Osborne for letting me escape the clutches of this dodgy bunch of charlatans.

    Of course, there are people who enjoy the personal finance sections of newspapers, and who love nothing more than poring over the small print of different finance options on offer, but I’m not one of them. I’m the woman looking for the switch for “financial autopilot”, and right now, with the changes to annuities, that looks suspiciously as though it might have disappeared from my dashboard.

    Money is crystallised power, a claim over human work. All power stores are dangerous if you don’t think about them. It’s why people don’t carry petrol around in open buckets and you learn something unique and instructive if you drop a spanner across a car battery. Endowments were the autopilot choice for a young ermine and it appears a young Joanna. The older ermine learned from that when his career flicked out of autopilot, and so should you, Ms Moorhead. ‘Cos the ground is never far away, and it has an unhealthy attraction for things above it.If you fail to plan, you plan to fail.

    Thinking is about ten times as hard with pensions than ISAs because of the decades it takes to get into them, and the hopefully over decades they will serve you. The Grauniad seems to be in jealousy mode all round at the moment, as they are bitching that you need a salary of £125,000 to make any use of the the New ISAs. FFS people – I have never, ever, earned anywhere near that much and I have zero income at the moment but I am damn well planning on using my full NISA allowance over the next few years. Dear Guardian, have you ever heard of that antiquated notion, spending less than you earn and saving money? You guys should try it sometime, instead of sipping your cappucinos and griping. No, if you spend your nice Guardian salary on consumer shit then a NISA is no use to you, but you get lots of lovely toys. Each to their own.

    small changes make big differences

    You don’t see an awful lot about pensions on PF sites because they’re hard, they are built up over secular 1 timescales in general and small changes can make mahoosive differences. Let me illustrate this with an example. In 1988 I joined The Firm’s final salary pension scheme. It had a simple proposition – every year you accumulated entitlement to 1/60th of final salary, with a normal retirement age of 60. In practice than meant if you worked for The Firm for 30 years you would get half your final salary as a pension. The Firm expected pensioners to die at 80 on average, thus paying out for 20 years. You could retire at 50, in which case they would pay out over 30 years, 10 years longer than planned so they would actuarially reduce your pension by 50% – you lose roughly 5% for every year drawn before normal retirement age (NRA) of 60.

    The Firm decided it wanted to reduce costs, so it closed this scheme to new entrants in 2001. In 2009 it decided it wanted to save even more money.  It appears UK law doesn’t permit firms to claw back pension entitlements already earned because they are part of your pay so they have to contractually honour previous years agreements. But they can change things going forward. So The Firm changed three things, and very few people spotted how much damage was done to their pensions. The Firm

    • changed the NRA from 60 to 65
    • changed the accrual from 1/60th to 1/80th
    • changed the accrual from final salary to career average (each year’s entitlement is based on the inflation adjusted salary for that year)

    Three small changes – HR obviously wept the usual crocodile tears and said it won’t make much difference for people retiring soon, and allowed people leaving up to three years from 2009 (just excluding an ermine – I was six months out of the grandfathered rights date 🙁 ) to leave under the original terms. Now who is most interested in pensions? Old gits, who are about to leave. So HR shut them up by grandfathering them.

    Let’s take a look at what that did to me

    how the the changes affected my pension

    how the the changes affected my pension (rebased to 60 and a nominal 10k final salary)

    Now I obviously surrendered some pension accrual leaving 8 years early, but the changes made that easier to do – I was giving up less. It’s also relatively simple to see that the total change is about 25%, which coincidentally happens to be the amount I was able to save in AVCs and will take tax-free as a pension commencement lump sum and invest myself in my ISA, effectively creating a tax-free DC pension to compensate for the loss due to retiring early. I will still have less because I will draw the pension a little early, though part of the reason for writing this is that has changed with Osborne’s changes. I may defer it for another year or so and use a personal pension, because as a non-taxpayer I can get a free 20% bump up on £2880 or ~£5700 and getting a 10-20% ROI on cash is difficult to ignore in a ZIRP environment 🙂 It isn’t a lot of money, but it’s worth thinking about.

    Now imagine a 10 year younger ermine, entering The Firm just before the portcullis closes on the final salary scheme.

    The younger ermine eats a much greater hit

    The younger ermine eats a much greater hit

    The poor bastard takes the same hit as the old Ermine, but he has to suck it up to 60 to get the same amount as the old Ermine who pulled the big red ejector handle it in his early fifties! Now the younger ermine probably takes an even greater hit because of the career average change, which reduces the base salary on which the pension is calculated. And The Firm was craftily shifting more and more pay from consolidated rises to bigger bonuses, and bonuses weren’t pensionable.

    Now the proposition of a final salary pension scheme is simple, so if small changes can make that sort of effect, the sort of thing the Chancellor has done can make even more effect on a DC pension. Let’s take a look.

    Osborne’s Budget changes

    To a first approximation, he’s lifted the restrictions on what you do with the money once you reach 55. The Government’s own summary is pretty good. People younger than  42 should beware that this age will be dragged up

    this consultation also includes a proposal to raise the age at which an individual can take their private pension savings under the tax rules from 55 to 57 in 2028, at the point that the State Pension age increases to 67.

    so if you are younger than 42 be careful. If you are much younger then expect this to be drifted up to 60. That is the evil heart of pensions – governments can change the rules after you have locked the cash away. If I personally were younger than 42 than from a purely financial POV I wouldn’t touch pensions with a bargepole, except enough to get any employer match, and perhaps to lose any 40% tax. But that’s me – YMMV. That’s not saying I wouldn’t save for retirement, but I’d use ISAs for that. However –

    There are some things only pensions can do

    1403_avoverThis judgement isn’t as simple as it seems, however, because one of the advantages of a pension is that it can’t be seized by most creditors or held against you for many benefit claims. You may be doing fine and swimmingly at the moment, but globalization and technology are shifting the balance towards capital and away from labour. Pensions help you build capital safe from the backdraft of this. If I were a younger Ermine in my 20s but with the older head of now, from what I have seen I would not expect even a good job to last for 30 never mind 40 years. The power is shifting away from workers, the pace of change is too high and increasing, and the winner-takes-all effect is too high. Tyler Cowen’s Average is Over shows the way – reveiwed in The Economist. I would place greater effort on escaping the rat-race earlier and owning capital rather than relying on my rapidly depreciating labour. The time for consumer frippery and shitloads of debt is over. I have no desire to live like a Transnational – I am not ambitious enough and probably not bright enough.

    Many people my age have been caught on the hop by this – the increasing routine and rottenness of my job, and the micromanaged incentives are the first reaches of this shift of labour to capital. When I see a business card that says ‘Consultant’ and I see grey flecks in the hair of the holder I mentally translate into ‘Unemployed’ – because so often it’s true 😉 It heartens me to see that in the UK PF community there are more and more people who are looking for financial independence at much younger ages than I am. I think these are cleverer people than I was, who are picking up the straws in the wind of the incoming shitstorm for jobs. Get on the side of Capital, because Labour is losing the fight, unless you can get on the side of the 1%, and let’s face it, the odds aren’t great 😉

    Society will eventually have to shift. Look at some of the changes coming – the increase in the personal allowances, meaning an increasing number of voters will not be taxpayers. They will, of course, vote for jam today and for somebody else to pay. Look at the stats on tax income – over two thirds of the income tax take comes from people earning 32,000 and above. These are people who individually earn more than the median net household income for families with dependent children 2 in the UK

    Pensions can help you with this, basically by locking up money against the incoming shitstorm and throwing the key out to your future self many years in the future. You can hitch a ride for your future self  on the side of Capital (if you use equities rather than cash) that, in current legislation, can’t be taken away from you 3 and it doesn’t impair your ability to claim benefits 4. Whether that is attractive to you depends on your view of the world and where it’s going, and to some extent your rate of discount of jam tomorrow compared to jam today.

    So what did Osborne change?

    There’s a common belief that you had to purchase an annuity with a define contribution pension but that was never true until you reached 75. Those with £20,000 of guaranteed pension income could take any amount of their money subject to tax and those with less than that amount of guaranteed income could draw down their money at a rate determined by annuity rates in capped drawdown. What he’s essentially changed is that anyone over 55 can take as much of their pension capital as cash, subject to normal income tax as opposed to the punitive 55% rate it used to be. But if you are taking £150,000 from your pension for that Lamborghini then you’re paying 45% tax on all of it, bud, so you better strike a deal for no more than £82,500. Previously it would have been 55% taxed, so you’ve have got 67,500. Put that way it isn’t such a stupendous change for high-rollers, though £15k probably gets you the walnut trim or the gold-plated gearshift knob.

    The rate you get for an annuity rises as you get older – annuity rates for people at 75 are much better than for those at 60 or 65 because they’ll be paid for less time. There is much to be said for starting off in drawdown and switching to an annuity later on. Most people haven’t saved enough into a DC pension, and this gives you a better chance of a decent lifestyle even now – the annuity is not dead at all. Once the annuity return beats out the return you get on equity investment it makes sense to switch 5.

    People hate annuities because they can’t leave them to their kids among other reasons…

    But you don’t get to leave it to your kids. What seems to be behind a lot of the rumbling about annuities is that they die with you (they can look after a partner at some cost but that’s it). So the children get n’owt. Now the whole issue of capital and inheritance needs sorting out by some future British government, and it won’t be pretty. I’m personally of the opinion that inheritance is an abomination in a notionally democratic and meritocratic society. It harks back to older societies where capital accumulated very slowly so it was the only way to build a business – over generations, and it all smacks of the privilege of kings and nobles. There were no startups before fossil fuels. It may be the most natural thing in the world for parents to want to favour their children, but IMO a 100% inheritance tax where the entire estate escheats would be an incentive for those parents to sort their shit out while they are alive, and it would go some way to not embedding privilege. But I can say that because I am child-free, if that weren’t the case I would probably line up right behind the old buffers of the Torygraph who think that inheritance tax is a terrible thing, because having children does that to you 😉 Somehow society needs to sort this out in a world where it is increasingly difficult to make your fortune in a working life, because increasing inequality lets the 1% bid up the price of essentials like housing. God knows what the right answer to that looks like, but it doesn’t seem to me to be the direction we are going. History shows that aristocracy does work, but needs a lot of serfs…

    It’s important to note that one of the reasons annuities looked such horrible value in the last five years is that the Government’s policy of printing money and keeping low interest rates meant annuity providers couldn’t offer decent rates – the underlying gilts just didn’t give people the returns they wanted at 55 or 60. Osborne’s been a good guy in not forcing you to take an annuity, though remember you didn’t have to do that anyway. But he hasn’t improved your ability to get a low-risk income at a price you want to pay. You can stay in equities, as you always could with drawdown. But you are still SOL if you want to avoid the volatility of equities. You are going to run out of money if you didn’t like the annuity rates on offer when you retired and you can’t stomach the rollercoaster of the stock market. There ain’t anything better on offer at the moment 6 – as a cautious saver you have to do Your Bit to pay off the National Debt.

    NASA tells us we are doomed

    There’s a NASA report that paints a bigger picture, basically they are of the view we are Doomed

    …. appears to be on a sustainable path for quite a long time, but even using an optimal depletion rate and starting with a very small number of Elites, the Elites eventually consume too much, resulting in a famine among Commoners that eventually causes the collapse of society. It is important to note that this Type-L collapse is due to an inequality-induced famine that causes a loss of workers, rather than a collapse of Nature

    The bit they seem to be missing is that the Elites are busy eliminating the need for a lot of the workers… The Ermine is not an optimist by nature, but I have learned that the bear case always sounds smarter. This is because things go titsup in a big way, and they can be imagined – at the moment it’s robots and globalisation stealing out jobs, climate change, it’s easy to picture them. What is harder to see is that people chisel away continually at improving the upside. 99% of them fail, but the incremental up-shifts add up, but they fly below the radar because they individually don’t look that much. Who would have guessed that improved computer networking would spawn whole new industries like web designers and security experts and MOOCs and improved living standards for what we used to call the third world by letting them work for us 7, and high-frequency trading etc? After all, we had networking before – I recall Novell Netware, where the piss-taking bastards at Novell would charge you a licence per connection 8, and added a piece of code to explicitly kick people off if more people connected to a server. Then TCP-IP came along, eliminated such monopolistic gouging and ate their lunch. Then in ’94 Berners-Lee developed the WWW and here we all are. None of those developments looked earth-shattering at the time.

    At the moment the Chinese are working on thorium nuclear reactors that address many of the the hazards associated with nuclear power, though they will no doubt have problems of their own.It may or may not go somewhere, but if it does, then it will be a win for energy and for knocking back global warming, simply by taking out a lot of China’s coal-fired power generation. In general, positive change comes in small chunks that steadily mesh together and add up, whereas things that go wrong come in great big unexpected lumps that generally give us the feeling of OMG we’re all going to DIE. And the atavistic caveman in us looks at the great big shadows of our fears cast against the wall and it makes better copy. Bad news sells, and nobody’s managed to ever sell a good-newspaper yet.

    Pensions get a lot more interesting when you get past 45

    One of the primary risks younger people face in using pensions is that they’re saving a lot of wealth is a locked-up place that Governments can easily target, since Government sets the rules. A future Labour government could go back to annuities – I’m not saying they have thought of it, but them might. There is a general downdrift of the amount you can contribute to a pension (£40k if you earn more than that) and there is also a general downdrift of the total amount you can save in a pension and get tax relief, the Lifetime Amount which is currently £1.25 million. That sounds a lot, and I, for instance have nowhere near that much but for someone in their 30s now it’s not unreasonable to aim for, because the value of money roughly halves every 15 years. In thirty years’ time that would be worth about £312500, at a 5% withdrawal rate that would be a pension of £15625 p.a.

    You can see the direction of travel of pension allowances at HMRC, and it’s not positive. A whole lot of these problems go away as you get closer to drawing the pension, because, recognising that people can’t take money out of a pension to conform to changing legislation, they often let you protect your savings against changes. The quid pro quo for that is that you stop saving into a pension. Totally and for the rest of your life. That’s not so bad if you are in your late 40s or fifties and drawing at 55, after all HMRC indicate you are limited to a pension of about 56k at 65 so you are hardly on the breadline, you just have to stop paying into your pension for a few years, pay a bit more tax and use ISAs but if you are a young buck at the top of some financial institution, Doing God’s work, say, then your dreams of retiring to round the world yachting and golfing will need you to find some other way of saving for retirement. If you are that rich you’re not reading this, and anyway, you can afford to pay for the relevant financial advice on what to do.

    taxpaying wannabe early retiree old gits, your boat’s come in

    If you are a taxpaying old git, however, you are all of a sudden much better off, particularly if you have savings or are prepared to borrow money. Drive your salary down to the personal allowance by putting everything above that into a personal pension. Do that for a couple of years, and then when you stop work extract this money but leave your main pension deferred (ie still in accumulate mode) – the first £13k a year is tax-free 9. Obviously you need a big spreadsheet and do a lot of what-iffery to play off any loan/mortgage not paid off against the tax bung, and it only works if you can slow your rate of withdrawal to less than the personal allowance. There’s no point in saving 20% tax to pay it again later.

    ageing 40% taxpayers and child benefistas – this one’s for you

    However, if you are a 40 or 45% taxpayer than you can make out like bandits  – squeeze yourself down to the 40% tax threshold and accept you pay 20% tax on the way out. It’s free money 🙂 Well, it isn’t, it’s a way to stop the Government stealing your money, and I wish I’d had this available to me. Fill your boots, and if you are a child benefista than you can go get that too. It’s welfare for the better off…

    one of the obvious things for a non-taxpaying old git to do

    Is save £2880 into a personal pension, saved as cash. In a curious fit of minor generosity, HMRC then up this to £3600. In my book that’s a profit of 25%. Do a couple or three of years of that and you end up with a profit of about 10%, because inflation will knock off about 5% of the return. And my DB pension gets 5% bigger because I draw it less early. I initially started looking at this to see if I should do some of that this tax year, but there isn’t enough time to see what exit charges are like – all the pension providers’ websites seem to be based on annuities and the like. So I will forego my free bung of £720 for this year from HMRC because a few days isn’t long enough to get this right.

    I researched pension costs at Cavendish Online which seemed to be an often suggested good value broker on MSE. For a simple and quick in-out you will probably favour a stakeholder rather than a personal pension, because costs appear to be lower, and non-taxpayers are going to be playing with £3600 a year at most. A personal pension gives you some more flexibility of investment choices, and a SIPP is the most flexible. You pay more charges are you go up the hierarchy. What I couldn’t determine was the exit charges.

    There is still a while till I get to 55. After than an immediately vesting pension plan (IVPP) seems explicitly designed for non-taxpayers, and hopefully by then these will return 75% of the capital as cash, rather than as an annuity. To be honest I would expect some future Chancellor to block that particular loophole. Unless they take pity on all us impoverished non-earners on the assumption that we are all poor, rather than enterprising – once I discovered how much income was taxed turning it into wealth before it got stolen became a priority.

    I don’t have enough expertise to know much about the issues for younger folk – the big risks of Government fiddling are high, but on the other hand the protection from creditors is a great plus point. Shit happens in a working life – the big ones of Redundancy, Divorce, Disease are always with us. Death hopefully less so – one of the reasons the retirement age is drifting up is because you young’uns will live 10 years longer than me, and probably in better health.

    These pension changes are particularly transformational to wannabe early retirees – ie those who want to retire in their mid-fifties rather than at 60 or 65, and particularly those who are paying 40% tax. If this includes you, you would do well to try and look at these changes from every angle to see how they could help you reduce your tax bill or delay the point at which you take you main DC pension. I haven’t had time to give this enough thought. Unlike Joanna Moorhead, I’m prepared to put some thought into how to make this work for me.

    What about those Lamborghinis and BTL sky-rocketing house prices then?

    There are two dark fears raised. One is that people will blow their money on frippery, and the other is that people will charge into BTL and jack up the price of houses again.

    Lamborghinis, cruises, consumerism gone wild

    Guess it’ll help the economy in the short-term ;). I’ve always been puzzled by how people go mad when they retire normally (60/65) and spend on a big blowout holiday. Your capital is at its highest potential at the point of retirement, a lot is going to change and you don’t know how it will feel to live off capital. That 25% PCLS is part of your overall wealth – it isn’t ringfenced for stupid spending. It’s a very, very different feeling to living off income. Blowing a lot of it at that point always struck me as a really strange thing to do – if you wait a year then you will have chilled, plus you’ll actually know whether you really want to spend a lot of money on the extravagant dreams of a cubicle slave thinking ‘Anything but this’. Booking the cruise while you’re still working seems odd. But I am different from other people. According to the BBC it appears not to be too bad a problem in Australia where they have this sort of thing already

    Hordes of greying BTL investors jacking up house prices.

    The average DC pension amount at the moment is £17,700 and about 320,000 people a year currently start drawing DC pensions. It’s probably not enough to seriously shift the needle on the dial, compared to daftness like Help To Buy

    Final wealth warning

    I’m not a pensions expert, and indeed had to research all this about DC pensions since the Budget because there seemed to be an opportunity. I can afford to screw up there, because this is only a small piece of my retirement planning to try and bag some free money. This post is tossing out some ides. Some may turn out to be hogwash. For God’s sake take advice if changing anything about pensions, or very, very seriously DYOR. After all, I bottled on £500 of potentially free money because I came to the conclusion I don’t understand the opportunities yet. That’s okay. It’s hardly a life-changing sum and it’s better to get it right that save £500 and pay £600 in charges! Be careful out there.  I am sure that somewhere in this septic isle there is a bunch of ne’erdowells crafting a website with a dodgy proposition to separate these newly freed pension amounts from their rightful owners…


    1. in finance secular means over periods longer than the typical boom/bust business cycle of about five to ten years
    2. ONS Statistics on the average family income, UK
    3. Divorce is one exception to this
    4. I believe this was not necessarily the case for Universal Credit. However, it looks like Hell will freeze over and the devil will learn to dance before Universal Credit is launched, so I’d lump that in with the general uncharaterised risk of Government Fiddling
    5. as is usual with pensions there is a whole shedload of issues that complicate this in favour of annuitising earlier, in particular your attitude to risk and your health
    6. You need to learn or take advice about getting the mix of asset classes right because the volatility of a 100% equity allocation is probably bad for the old ticker of a retiree 🙂 Although mathematically it gives you the best chance giving some of that up with a stocks:bond mix for a smoother ride is probably called for.
    7. that’s hellaciously First-World centric, and it’s transiting to we will all work for our Transnational Corporate Overlords, since the erstwhile Third World is busy taking the fruits of their labour and turning into Big Capital. The First World’s first-out-the-gate advantage is being competitively thinned out.
    8. or you could be fleeced per server. Either way they had you by the short and curlies and needed to be destroyed by the Invisible Hand
    9. That’s £10,000 personal allowance plus ~£3k tax-free PCLS
    10 Jun 2013, 2:50pm
    personal finance:


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  • I don’t often agree with Ed Balls, but on pensions he has a point

    The pugnacious Ed Balls delivered himself of the opinion that since the Government is boracic lint, the state pension should be included in Osborne’s cap on welfare spending. And it’s for the Torygraph all hot and bothered.

    Let’s first get one fallacy out of the way. The Grauniad and the Left in general are keen to lump the state pension under the title of benefits, in an attempt to bring it under the general benefits aegis, particularly as it’s the largest area of benefit spending. Take exhibit A, extracted from here

    Benefit spending graphic

    Yowza. Look at the BIG SCARY load of spending on PENSIONS, the BENEFIT SCROUNGERS – YOUR MOTHER!!!

    Not so flippin’ fast, benefistas. Unusually for benefits, to get the State Pension, in general you have to have been paying IN to the system, for 35 years as it will soon be. Unlike, say for housing benefit, which has been artifically inflating the price of housing in parts of Britain, which is the next biggest lump, for which you don’t have to have been paying in.

    So it is different. Something actually got lobbed into the pot. I’m not bright enough to be able to say whether it was anywhere near enough, but I do know that no NI contribution, no state pension. You get means tested pension credit then I believe, if you have no capital. Repeat after me, Guardianistas

    The State Pension is a contributory benefit, unlike nearly all other UK welfare payments

    It’s kind of in the title of the tax that was set up to pay for that and the NHS, though the difference was quickly diluted and chancellors hate allocated taxation. The title was National Insurance – insurance, geddit? In the years before the welfare state was set up, trades established friendly societies, which by taking a small amount from all members, could insure them against illness and death leaving their dependents destitute. Unlike the modern welfare state, however, the friendly societies did send the boys round in the event of a claim to establish whether there were grounds for it, at least according to the exhibit in the Somerset Rural Life museum I saw 😉

    Back to Ed Balls

    Having said that, he’s right to raise the issue. We have all gone on a mahoosive bender in the last 10-20 years, and Britain is nowhere near as rich as we believed we were. We will have to consume less, and material living standards will either fall, or rise more slowly than people have been used to. I’m actually on the optimistic side of the fence there, for the full Chicken Little treatment you can take a look Moneyweek’s The End of Britain and for a less breathless but equally dark prognostication Tullet Prebon’s Tim Morgan seems to be trying to scare potential investors shitless with Project Armageddon – might there be no way out for Britain, one for our American friends titled Armageddon USA with some marvellous depression-era iconography, and just in case you were looking for somewhere else to hide away from the Four Horsemen and the blowing of trumpets at the crack of Doom there’s Perfect Storm – energy, finance and the End of Growth. At least his boss, Terry Smith appears to have taken the hint, switched out the lights and is either building his safe room out of gold bricks while running Fundsmith, or having a quick laugh in the background while he builds his fund.

    Although there’s a case to be made that benefits that people have contributed to should be eroded less quickly than those that aren’t, the Tory triple lock is a brazen vote-winning approach that should be challenged, if only to have the debate. It’s one of the reasons I suspect there won’t be a State Pension by the time I am 67. It’s also, incidentally, one of the reasons that makes retiring and drawing my pension earlier more attractive. I can draw my company pension before 55. One of the key advantages in drawing one’s pension early is that it reduces the income that HMRC will taxes me on, as well as reducing my total income (because it’s paid out for longer). The latter effect is counteracted somewhat by the 25% tax-free pension commencement lump sum. In most people’s cases at The Firm that would reduce their pension, which would be nuts. However, I spotted that one could save this amount ahead of time in AVCs, and thereby avoid paying 40% tax on 1/4 of the total pension amount. This is then eroded by 10% due the the nasty tendency of cash to quietly die in the night, and I will move it into ISAs over the years once I draw my pension. Taxation will probably rise in the coming years, which is why I have emphasised ISAs as part of the mix, because I don’t want to be a tall poppy to that future government.

    But change is coming, because things that can’t carry on usualy have a habit of not carrying on, and Red Ed (2) has done us all a favour in calling it out. I admire him for his honesty (relevant section starts at about 11 mins in)


    This loss of living standards is going to be nowhere near as bad as it’s being made out to be, for people who are adaptable enough to rein in their consumer spending. Indeed, if the people who currently do their consumer spending on credit cards could only knock it off for long enough to pay their debts off, they could buy 20% more consumer tat at average credit card interest rates without paying any more – simply by saving up first! If I look back at the Britain I grew up into, Britain is massively richer now in nearly all respects, bar two.

    One is I would hate to be a child in modern Britain. The children I went to school with nearly all lived with both natural parents, and individual freedom in Britain  seems to have been bought at the cost of some societal cohesiveness. It was probably always tough at the low end, but now it seems tough everywhere. However, children have proven to be adaptable and resilient through the rest of history so it will probably come out okay in the wash.

    The other is related – as a child in the 1960s and even 70s  the world was a more hopeful place, technology was going to make things better, the grainy moon landings in 1969 I watched were going to be the precursors of shiny spacecraft going to colonise other plants, with Flash Gordon sort of fins. It didn’t happen – we gave up going to the Moon in the oil shock of the 1970s, and we are now scared that global warming is going to kill us all, and generally tomorrow is going to look like a worse place than today. I am glad that I had a childhood where the adults believed that things could only get better – even if they were wrong…

    Everywhere else, as far as I can see, we are so much better off. Our cars are cheaper in real terms ,they’re more reliable, we have an endless array of gadgets and nick-nacks to occupy ourselves with, communications are cheaper, far richer ,more extensive and faster. Travel is more widespread – I was 35 when I first boarded an aircraft, which probably sounds ridiculous to someone under 35 now 😉 Our homes are heated properly, we have a bewildering choice of entertainment. Healthcare is much better.

    So while Ed Balls is promising less for everyone, I do agree he is right in saying you should look across the whole welfare state, even if I don’t agree with him that contributory welfare are equivalent to non-contributory ones. In return for his inclusion of the State Pension to the welfare spending cap, I would like to see

    • child benefit restricted to no more than two children and no household with > £50k income (to address the shocking keening noise and the unfairness screamers)
    • the winter fuel allowance, bus passes and free TV licence iced from people with more than the average UK household income
    • and for unemployment benefit to have a large contributory component – like in many European countries

    however, since I’m not running for office it doesn’t matter much what I think. However, if National Insurance goes back to its roots and starts to look a lot more like insurance I’m for it.

    9 Jul 2012, 10:43am
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  • Government Guarantee against Stock Market falls – Mis-Selling Scandal ahoy

    Don’tcha just love something for nothing? Here’s a doozy – invest in the stock market, take the gains and insure against the potential losses? What on earth could go wrong.

    It’s like the philosopher’s stone, or the elixir of everlasting life, an idea that is almost numinous because it’s something we all want.

    Guaranteeing against stock market falls did for Lehman Brothers, so why did our very own Steven Webb, Pensions Minister not remember this recent history when he spake thusly

    Steve Webb, the pensions minister, said he wanted to give people “certainty” that they would get a guaranteed income when they retired.

    Steve, me old mucker, it ain’t gonna work. You did PPE at Oxford, so you were a damn sight cleverer that I was, but it obviously didn’t stick. Let’s take a butcher’s hook at the old plan, eh.

    Ministers fear that unless they can guarantee that pensioners’ money is safe, they will be deterred from saving.

    Now this raises a whole bunch of philosophical debates, of the sort that probably occupied fine minds in Oxford. What exactly does safe mean, f’rinstance? Most of your pensioners probably think put in £100 and get at least £100 back, that’s safe. It isn’t. £100 will buy you a colour telly now, it may not buy you a loaf of bread in thirty years, if the economy fails, if energy gets a lot more expensive, if climate change means you can’t grow wheat. It’s called inflation, and it’s how governments lose excess debt. You should know that, Steve, because the Government you are part of has been doing just that. You’ve destroyed 25% of my lifetime net worth over the last five years, by printing money and making it less valuable. However, perhaps the proles aren’t up to spotting such legerdemain, so we’ll conveniently look the other way.

    More fundamentally, however, who is doing the insurance job?

    The policy, provided by private insurance companies, would guarantee savers that their pension pot on retirement is worth at least the combined value of their contributions, their employers’ contributions and the tax relief they have received over their working lives.

    Right. How is that going to work then? Does it come with an implicit Government guarantee, in which case FFS lose the private sector, as all they will be doing is paying bankers bonuses in the good times and letting the taxpayer carry the can when it all goes titsup. That’s the trouble with insurance, it works most of the time, but it is like a flawed sword. It fails you in your time of greatest need, shattering into a thousand empty promises.

    There are many things in life that gain their power from their inherent heart of darkness. It is the possibility of 100% losses that makes investing different from saving, it is the negative counterbalance to the possibility of investment gains. Diversification can mitigate this effectively, both temporal diversification (pound cost averaging) and stock and sector-based diversification. But the risk of investment is inherent – you are capitalizing other people to take risks on your behalf. This risk is the fire that feeds the flame. The price of eliminating the risk is about as much as the potential return. The stock market is a hellaciously noisy signal superimposed on an almost imperceptible drift upwards, though you assume some of the fundamentals of industrial civilization hold or be replaced by equivalent value if you’re going to project that drift into the future.

    The real return on a diversified portfolio is low. Eating an insurance cost of 0.75% could well shave off 20% of your real investment return, year on year. That may be a fair price to pay for  peace of mind for some people, and it may even be good value in the last 25% of your retirement savings career (55-65) but it may come at a high cost in the early days of your retirement savings.

    The worst thing about this is that Steve Webb plans to deliver the future pensioners of Britain into the arms of the rapacious financial services industry, rather than telling them how to achieve the same result themselves, as Monevator describes here.

    There’s a mis-selling scandal brewing in this one…

    13 Jan 2012, 8:38pm
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  • Life Cycle Financial Planning

    Looking around me, I see quite a few semi-old gits pumping money into their pensions, and lots of it. I’m one of them. We’ve all got it horribly wrong, you should start saving when you’re young.

    Optimum pension contribution rate from the paper referenced by the FT. There is some similarity with my AVC contribution rate.

    I was tickled to read in the FT that maybe we’re not so daft after all. Why Starting a Pension Early Could Be a Mistake originally appeared in the Financial Times  Merryn Somerset Webb puts far more accurately succinctly what I’ve been driving at with Compound interest is Overrated.

    I was probably wrong – compound interest is all very well. Why it doesn’t work as well as people like to make out is that in your twenties you can’t put any decent amount of money into a pension, because of where you are in your financial lifecycle. You’re not earning much, so the basics of life are a higher proportion of your outgoings. And you’re starting out in life, so you aren’t as financially savvy as you may get, plus you have to buy lots of stuff to establish life as an independent adult. Merryn gets to the heart of the matter

    We all think that we should start saving into our pensions from the moment our first paycheque hits. But it turns out that if we were “rational life-cycle financial planners”, we would wait until we are into our mid-thirties to save.

    Everything we do financially should be to maximise our standard of living over our life cycles. In our early career years, when our earnings are low, we compromise our living standards if we save.

    So we should consume our initial incomes and then step up savings as we earn more: with the percentage rising from zero before age 35, to 30-35% as we head towards 60.

    Now I haven’t followed that exactly, but there has been a huge increase as I’ve got older. And as Merryn intimated, it gets so much easier to save as you get older, though with the caveat that having children and aspiring to help them with university costs can put the kibosh on that. Previous generations  became financially independent of their parents as they came of age, making saving easier for the parents once they got into their 50s.

    The takeaway isn’t that you should blow it all in your 20s – you should still be saving or building capital. Either in house equity if that is your bag, and you expect house prices to continue rising (why?) or in financial instruments to give you a passive income, which is equivalent to home ownership reducing your housing costs.

    It’s hard to know the benefit of not having housing costs until you experience it. In my twenties I perpetrated the biggest misallocation of financial resources in my whole life by buying a house at the peak of the market, signing a mortgage document that was to be discharged in February 2014.

    That screw-up was redeemed by paying down that mortgage about six years early. Not having to pay the mortgage means I can save much faster, for the simple reason that I need access to far less of my salary. Using salary sacrifice I can stop the Government stealing a lot of my pay, allowing me to save two year’s gross salary in three years by booting much of my salary into pension AVCs.

    I don’t have to live on thin air 🙂 I live on an annual expenditure of less than the national minimum wage, but I have a standard of living that is much higher than you’d expect from that because I am using the accumulated capital from earlier years.

    That is why compound interest doesn’t benefit me much in investment, I haven’t got the 40 years it takes to do anything useful at a 5% compounding rate – but that doesn’t greatly matter. I focused my investment as a young man in paying down my mortgage debt. That is still working for me – by dramatically lowering my costs so I can save and invest now.

    Investing is a dangerous game, particularly for the young-ish and optimistic – I was slaughtered in the dot-com bust, largely from being too hot-headed and not knowing some of the ropes. You can get round some of that as a young investor by using passive investing, provided you start at a good time when equity market valuations are cheap. If you passively invested in the dot-com boom you’d still have been slaughtered in the last ten years, just not as quickly and perhaps not as comprehensively as I was. (edit – no you wouldn’t – see this comment for why)

    Am I a better investor now? It’s impossible to know without looking 10 years ahead. I have better guidance, I have the learning from last time, and I am richer, so I won’t become a forced seller because I have more than half my non-pension savings as cash. I diversify by sector and to some extent by geography, though not financial asset-class, I’m either an equities guy or into non-financial assets. Well, apart from cash, I guess.

    It surprises me that there’s so little said about life cycle financial planning. If you’re wealthy enough to be doing financial planning, you will probably experience a similar sort of life cycle. Yes, timing will be different for people who have children, but the arc of the life-cycle will still follow similar stages – you’ll probably be skint and capital-poor when young, you’ll be better off though probably with more dependents when middle-aged, then more capital rich but with a lower income when older. Saving 5% of my salary was a much bigger ask in my 20s than saving 70% of it in my 50s.

    I was lucky in a lot of aspects, despite being hopelessly incompetent with the housing market.  Rolling with my financial life cycle was probably one of those pieces of luck. I didn’t sit down to do it at 30, though some of it was instinctive in following the financial life-cycle of my parents, who discharged their mortgage when my Dad was in his late 40s, earlier than me.

    Someone in their early 20s who takes Merryn Somerset Webb’s article and uses the information with self-knowledge, determination and persistence could do well by maximising their life-cycle standard of living. Of course, the need for self-knowledge, determination and persistence at 20 may be the rub. I struggled with the self knowledge, else I would have listened up and not bought a house at a market peak because I wanted out of the endless having to move because of other flatsharers’ life decisions.

    Anyway, in one sense I was wrong about compound interest being overrated. It’s great. It’s just not useful to most of us who start out their adult lives skint and with massive claims on our income for the necessities of life. Obviously if you start work at Morgan Stanley in your twenties, fill your boots and all the great stuff about compound interest will come good for you.


    For the more analytical, the Pensions Institute papers referenced by the FT are

    Age-Dependent Investing: Optimal Funding and Investment Strategies in Defined Contribution Pension Plans when Members are Rational Life Cycle Financial Planners by David Blake, Douglas Wright and Yumeng Zhang (Sept 2011)


    Target-Driven Investing: Optimal Investment Strategies in Defined Contribution Pension Plans under Loss Aversion by David Blake, Douglas Wright and Yumeng Zhang (Sept 2011)

    28 Dec 2011, 11:51am
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  • How I Got Away With Not Saving For a Pension in my 20s

    The standard advice for anyone in connection with pensions is start early, young man, start early. Do it, and do it now – your early savings are what makes all the difference.

    I didn’t. I effectively started at 28, and even worse because I want to retire early I effectively started later in my working life. For a normal worker in my industry retiring at 60 I would have been saving for 32 years whereas I’ll be lucky to reach 25 years. I’m therefore like a normal worker starting at 35. Because my company pension is a final-salary one, the difference is less than it would be with a DC scheme. However, I’ve had to make changes in the last three years to try and make up for the difference.

    Because I own my house outright this has been easier for me, and it make me wonder if the standard advice is simplistic, and people should take a systems approach to their lifetime finances. In a later post, I will try and work out what proportion of income I did spend on the various key aspects of life (housing, hedonism, tax and pensions). The information isn’t precise for some of the early years, and yet I believe it shows that as long as you do save for some key asset classes in your 20s, it doesn’t have to be a pension in those earlier years.

    I’ve analysed  my working life, and mortgage, rescaling values to eliminate the scourge of inflation which makes it so hard to compare values over a thirty-year working life. Here, I have looked at various pension saving scenarios and how they would work out, as if I were saving into a defined contribution pension at 15%, about twice the rate of NEST’s 8%. Defined Benefit (final salary) pensions are better than NEST largely because more money goes into them, usually from the employer so it is not always visible to employees. However, a pension is deferred pay, so two employers both offering  the same salary but one offering more contribution to a pension are actually offering different salaries.

    First off, an extreme wealth warning. If you are in your 20s and looking for an excuse to live it up at the expense of saving this is not your ticket to ride. You have far more unknowns ahead of you that I have in describing this story, because I am in my early 50s and my career trajectory is known. If you’re young and you use this to justify not saving your 8% of income into a pension then you need to save 8% of your income into some other asset, and assets do not include most of the things you might want to buy 😉

    I got into deserved hot water over here for the assertion that you can make up for a lack of saving in your 20s, and that compound interest will not necessarily ride to the rescue. Not because I didn’t get away with it, but because

    @ermine — Thanks for the follow-up. I’m going to argue strongly against what you’re saying, for the sake especially of young readers reading, as I think it’s dangerously misleading.

    […] I don’t want Monevator to help put people on the exactly the opposite path that I set out to postulate, and that we post on every day – i.e. at a minimum, realistically aiming to achieve financial security within their lifetime, or better yet some financial freedom.

    Consider yourself warned young person, Monevator is right in that you can’t know until you are 50 that you won’t take some important hits I didn’t. I am looking back over my working life and I know what happened. Young reader, you are looking forward over an unknown career arc. You may have less luck that me. In particular, if you are a woman in your 20s do not follow my path. I will explain why later, but you are exposed to more serious risks statistically that men at the same age. It’s not feminist, it’s not fair, but it seems to be what happens, and you should protect yourself against the world as it is, not as it should be.

    Having said all that, I consider this pretty clear proof that the magic of compound interest is not all that it is cracked up to be, and that is is perfectly possible for someone who has a career path similar to mine to catch up for the lack of early pension savings in ther 20s. Observe that I did not accumulate any debts in my 20s, and my savings went towards putting down part of a 20% deposit on a house I stupidly bought at the height of the Lawson boom. For all the good those savings did me I could have drunk it all in the Television Centre bar and had twice yearly holidays in the sun, but I stuck with just reasonably excessive drinking and one holiday most years.

    The community that can take inspiration from this analysis is the one of the greybeards who didn’t follow the recommended route, and delayed saving till their thirties or even forties. As long as they didn’t screw up with debt, and as long as they paid their mortgage down at the recommended rate, they can recover without working till they drop, through the application of ERE’s methods, but perhaps calling it Earlyish Retirement Extreme

    Setting the scene – how I simulated different saving approaches

    To try and make sense of the last three decades, I have taken my salary and normalised it to 1 for my first proper job with the BBC in 1984. I am British, and unlike our American friends I just don’t like talking about how much I earn. Regular readers have probably roughed it out by now, but you ought to have to work for it.

    I’ve then rebased everything by scaling for inflation using the RPI index, setting that first BBC job to a nominal value of 10000 pounds. In the RPI adjusted world I have created, that 10000 pounds holds its value across the three succeeding decades, because I deflate prices and my salary by RPI inflation.

    an ermine's inflation-adjusted income and mortgage stupidity

    You can see that over the years I improved my income in real terms by over two times. The dip in 1987 was when I took an MSc with a Manpower Services Commission grant. You can also see that the ermine is taking a hit from the stinginess of my employer and the rampant inflation of late towards the end. The actual high-water-mark of my real income was in 2008.

    I’ve also represented my mortgage on that. Look at that awesome income multiple of what, 5 times? Millennials and the Priced Out generation take note, I had to stump up a deposit of about 10% to bring that multiple down to within spec so my debt was lower. I then had to borrow another 10% interest-free on a credit card advance to avoid taking the shaft from high loan to value insurance, which I paid down in the first year. Whenever it looks like a good idea to pay more than 4*salary for a starter house, STOP. You are either earning too little or paying too much, just like me 🙂 What isn’t shown here was I had an endowment mortgage which I only managed to conclude a mis-selling case on in 2004. Friends Provident sold a single ermine with no dependents a life insurance product, FFS. Fundamentally I shouldn’t have been so stupid, but at least I did get the situation restored to what a repayment mortage would have been (the endowment had fallen behind by 1/3). That payment from the endowment is why it looks like I robbed a bank in 2003/4…

    Although I was a feckless young ermine, taking my BBC final salary pension as a cash lump sum on moving to my current company, I am lucky enough to have been in a final salary pension scheme since then for the rest of my working life. Taking a leaf from SG, I have simulated that pension with a steady pension saving rate of 15% from my rebased and inflation-free income, compounding at 5% which seems a reasonable estimate for the long run stock market total investment return after inflation. Mind you, someone who has been saving using an index tracker over the last decade may take a dim view of that 5% assertion! I’ve then modelled how various different variants of me would have done with different pension savings strategies.

    Meet the Cast of Characters

    Steady Eddie

    First we have Steady Eddie. He starts work, saves his 15% gross into a pension scheme from 1983 until he retires at the end of 2010, 27 years later. He is the benchmark for how you should save into a pension. In all these graphs, the magenta bars are the parts contributed by the magic of compound interest. Note that most of this is Eddie’s own saving, though I do agree it would be churlish to deny the value of compound interest, as it makes up 48% of his pension capital.

    Steady Eddie. Take it slow, Eddie, this is how pension saving should be done

    He has experienced the same career progression in real terms as I did, so he earns just over twice as much as a greybeard as when he got his first real job. I normalised his wages to £10000 in 1984. I don’t count my very first job as that was a poorly paid technician post; I started looking for work in 1982, into the teeth of Margaret Thatcher’s first serious recession, so I took the first vaguely relevant job I could get. Eddie is sitting pretty with a pension of 6554 pounds in my normalised universe with a pension capital of £131000. That’s slightly under 40% of his average salary and 28% of his final salary. I am lucky; if I left and drew my pension now I would get a higher percentage of my final salary, and I am duly grateful for my good fortune in that I have had a stable job that has been interesting and rewarding for the vast majority of my time there, regardless of things that may have gone wrong in the recent past.

     Sensible Susan

    The only lady in the bunch, Sensible Susan follows the same path as Steady Eddie for 11 years. Ball-breaking feminists are going to hate this, but she then quits work to have children.

    What can I say? I’ve observed it happen that way often enough, and even if Susan returns to the workplace the missing years are critical to one’s career deveopment. Though my pay didn’t go anywhere in real terms in my 30s the projects I worked on built the platform on which I got the next decade’s rises. However, since she was sensible, Susan has built the classic early starter ‘magic of compound interest’ example of saving for ten years and stopping. Except I’ve had her save for eleven years, because I took time out to to an MSc in 1987 and it seems a bit tough on the Sensible Susan version of me to KO 10% of her earnings as well as well as have her stop work early. Articles like thisthis and this lead us to believe that the magic of compound interest will save her pension, but a casual inspection of her savings graphs relative to some of the later more feckless versions of me will show that just isn’t true. I have kept the vertical axes the same scale.

    Sensible Susan - the magic of compound interest (magenta bars) works for her but it doesn't make up for the serious lack of contributions

    Sensible Susan is on less than half of Steady Eddie. Compound interest makes up more than half her pension capital (66% of a total of £53000). She’s going to feel the pinch with less than half the pension of Eddie. On the other hand, she’s contributed less than a third of Eddie’s contributions. That she is closer to half than a third of his pension speaks something for the magic of compound interest but no way as much as you’re led to believe.

    Feckless Freddie

    He’s a lazy B’stard, our Freddie. He spends far too much time in the BBC Television Centre bar eyeing up the beautiful people of the luvvie set, who are far prettier, and, er, of the right sex, than the hairy-arsed engineers in the bowels of TVC where he works. As a result, he doesn’t realise till too late that London prices appear to be getting away from him. One day he ends up in the Broadcasting House bar (a classier lot in those days, the Radio types than Freddie’s Television Centre chums) and listens to yet another gorgeous sylph-like Rebecca and her pretty-boy BF talking about how much the price of their house has gone up and “oh gawd, Tarquin, ahhhrn’t we rich, dahlink”. On the radio Freddie hears Elvis Presley singing “We can’t go on like this”.

    and thinks to himself that yes, London, we can’t go on living like this, I am caught in a trap. As Freddie pulls his head from yet another pint of E.S.B. he looks up and gets his coat. Freddie figures he needs to go up the value chain a bit from being a studio engineer, and get away from the city that won’t let him live in it without paying exorbitant rent. After a Tube journey he gets on his bike to cycle up the Western Avenue from TVC to Hanger Lane, and thinks about a research job with more pay and a chance to buy a house. But first he needs to fix his ropey Batchelor’s degree. When he gets home he notes the beginnings of a gleaming white pelt starting to show.

    Yup, Feckless Freddie was me. I did the MSc, returned to London for a year then moved up to Suffolk. House prices were still sky rocketing, and I had to get on the ladder before it became out of reach. Oh dear…

    I did investigate whether my BBC pension could be transferred to my current employer, but it didn’t work out. If I had those three/four years they’d be useful but I’ve been here long enough it isn’t a huge amount. As a deferred pension it would be diddly squat, as it is referred to my final salary on leaving the BBC, so even if it didn’t lose over the years to inflation it would be referred to as final salary less than half of the one I retire on. So I used the £700 surrender value to a good purpose towards the deposit on the house. Oops…

    So how does my alter ego Feckless Freddie get on?

    Feckless Freddie and his Frantic Antics at the end

    The three yellow bars are the savings I have managed over the last two and a bit years, effectively twice my gross annual salary. If we ignore these, we still see that Feckless Freddie has an accumulated pension capital of £78000, less than Steady Eddie but still a lot more than Sensible Susan. Why is this? It is because twenty years of compound interest doesn’t make up for Susan’s shortage of contributions, and this is made a lot worse by her lack of the boost provided by career progression.

    It is the weakness of compound interest at realistic rates of real return, combined with the fact early pension contributors are contributing from a low earnings base that means all those stories about early starters staying ahead are just wrong. Feckless is obviously feckless, because he is about half short of Steady Eddie. However, he’s paid off his mortgage by the end, so he can now hit the tax-advantaged pension savings hard. His risk of the government shafting his plans is reduced as he is within a few years of drawing his funds, and the tax-free-pension-commencement lump sum could be just the ticket to make up for his fecklessness earlier. Feckless Freddie ends up with £129k, compared with Steady Eddie’s £131k. After three years of austerity, Freddie can sign up for his pipe, slippers and cruise brochures too.

    The fact that Freddie ends up with the same as Eddie isn’t totally coincidental. I targeted making up for the lack of pension contributiuons due to my missing years as well as compensating for retiring early. I can’t compensate for both unless I work another two or three years, but I can eliminate one. The bar was set by what my own pension would be if I stayed to 60. My assumed real rate of return was 5%, and though I can realise that as dividends I don’t believe I will get a total return of that much even though I have bought mostly since the crash, and a lot at the early 2008 low. I think my share capital value will fall behind inflation in the years to come, but this will hopefully happen slowly so if won’t kill me off in the period between leaving work and actually drawing my pension. If my share capital and dividend income starts to get nuked, well, that’s why I have about the same amount as my shares ISA in cash savings, because there is the mother of all economic shitstorms coming our way. I won’t be a forced seller in that intervening period unless the value of that cash is destroyed because this sort of thing happens.

    Looking at Sensible Susan’s holdings, note that what early saving and compound interest have bought her is insurance. She is unlikely to be totally unable to work again, and if she returns to the workforce then some of the same techniques used by Freddie are open to her. She is likely to reach a lower maximum salary in real terms than if she hadn’t taken time out of the workplace because other workers will have been honing their skills and schmoozing their way up the greasy pole in the gap, but there’s nothing stopping her making up some of the difference. Had he not done something drastic, Feckless Freddie would be closer to her pension than to Steady Eddie’s.

    Finally, let’s meet

    Stupid Steve

    Steve couldn’t see the point of all this saving for retirement malarkey, life was for the living here and now. He’s been a bit stupid, really, our Steve, and only started saving for retirement for the last ten years of his working life. He’s almost like Sensible Susan in the number of contributions, but what makes him stupid and her sensible is he did it the wrong way round. Everybody tells you you have to save early on, right? So what happens to Steve, he’s going to get slaughtered, right?

    Stupid Steve loses out, but not as much as people would think, since his contributions are twice as high as Susan's

    He’s had the same career progression as I did, so his pension contributions are made at the peak of his earning power. He’s on a pension capital of 43,000 compared to Susan’s 53,000. But he’s still got one ace to play that she doesn’t necessarily have. He’s still working, so if he manages to sock away twice his gross salary towards the end, getting himself up to 94,000.

    Now there are some things about Stupid Steve that make you think perhaps he may not be the most financially savvy cookie. But there may be mitigating factors. Say Steve is self employed, and he’s been building up his business all his life. When you or I leave work, we have nothing to show for it expect a few beers down the pub, a gold watch and of course the pension. When Steve leaves work and retires, maybe he has a viable business he can either get someone to run and it pays a dividend, or he can sell the company as a going concern and recover the capital he built up over his working life. Suddenly Stupid Steve isn’t so Stupid at all, perhaps he is Smart Steve. He’s only doing the pension saving at the end because it’s rude to say no to a 40% tax break with five years or less to run.


    The advantages of compound interest are vastly overrated as they apply to real-world pension saving. Real people

    1. don’t have enough time
    2. can’t get enough real investment return
    3. haven’t advanced enough in their careers

    for the much vaunted example of Sensible Susan ending up with more pension capital than Feckless Freddie, even if he starts 10 years later. They’d have to achieve an investment return of > 8.5% in real terms for that to be true, and it just ain’t going to happen.

    The main thing you buy by saving into a pension early is insurance – against long spells of job loss, unpaid sabbaticals or incapacity.

    Earlyish Retirement Extreme

    The message to greybeards who have spent too little time saving in their youth – there is hope! You can do it. Austerity is a lot less painful for a 50-year old with their house owned mortgage-free than it would be for a 25-year old. Most of the things that are wrong in my life are to do with the fact I am working, the environment is enervating and it consumes a lot of my time. Very few of the things wrong in my life can I solve by spending more money!

    The Archdruid identified the key issue in this post.

    What most Americans do not know, and have no interest in learning, is that it’s possible to be poor in relative comfort.

    I found the transition, from a normal average consuming lifestyle to one of consuming less, very hard. I was far more motivated to go through it because I was under the impression I would become unable to work or ejected from work in months. I wouldn’t have been able to complete the transition otherwise, but after six months of consumerism detox I was off it.

    Above all else, if you’re doing Late Retirement Extreme saving as opposed to Early Retirement Extreme saving, you are probably saving at the peak of your earning power.  To save in real terms what I saved in the last nearly three years would have taken me nearly seven years of saving at the BBC – I didn’t work there that long! Plus my outgoings were a higher proportion of my pay than they are now; what would I have done about paying the rent? Not only that, the money I saved would be locked away for three decades for governments to try and get their sweaty mitts on it, and I would have saved less tax.

    As for seven years staying in my sleazy bedsit as opposed to three years reduced outgoings at home with the lovely company of DW, well, I dunno. Getting on isn’t all bad 🙂

    the young person’s dilemma

    Even for young people, and subject to this dire warning I’m just not so sure that locking your savings in a pension for 40 years (by the time you are 30 the retirement age is probably going to be 70+) is the best thing to do with any cash you may be able to save between 20 and 30. There’s lots of contrary opinion, like this and this to the effect that I am wrong here, so you have to make this call yourself. The primary risks that mitigate against later saving are if you expect to take significant time out of the workplace to pursue lifestyle choices or you expect career progression to be lower than mine. Taking time out tends to lower career progression, switching jobs between and within organisations more than me tends to increase it.

    Look at those charts, and they are for a relatively short working life of thirty years, compared to 40 or 50 years that are implied by State retirement ages of nearly 70. As long as you start by the time you are 30, giving you 40 years to save before retirement, I’d say there may be other more pressing calls on your saveable cash. After all, though I was a dipstick for using my BBC pension funds towards a house, the financial strategy was right – put this into a capital asset. You recognise an asset because it either saves you more money in its lifetime than it costs you, or it pays you an income.

    A house is a capital asset if it saves you rent, and the many reasons for not buying a house don’t outweigh the many reasons for buying a house. Machinery, services and supplies for a business are an asset if the business can turn a better profit than the cost of those assets properly depreciated would return on the stock market on in a bank. Your van is an asset if it lets you get more work than it costs, your Ferrari, designer suits and your Sky subs are not assets.

    So as long as you understand assets, and as long as you save into assets or RPI index-linked cash the amount you would save into a pension (at least the equivalent of 8% pre-tax), I would say a young person might do well to take a strategic view that saving to a house or saving to buy assets for a business or saving cash is more relevant to their financial lifestream. Pensions advice is so one-dimensional. Do it. Do it now. How about no, let’s work out that this makes sense?

    Assets can help you save in a pension later on. My house contributes £9800 p.a. to my pension saving – it would cost me £7k to rent it but I don’t pay myself rent or a mortgage and I’d have to pay 41% tax and NI on that, which I save going into a pension. That’s not a bad ROI, it’s actually over 10% p.a. on the RPI adjusted price I paid for it.

    There’s a time and a place for pension savings. As long as you heed the dire warning and understand it, I’m not so sure between your 20s and 30s are that time. Just save that 8% of income somewhere accessible and tax-sheltered if in financial assets. Yes, you’ll lose the tax break now, but heck, you’ll probably pay basic rate tax on it on the way out so don’t sweat it. Who knows what tax will be in 40 years’ time! It is possible to make up for lost time. The amount I have in pension AVCs alone is enough, at a real return of 5%, to compensate for the six years of contributions I am short.

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