And the sustainability of some private sector pensions has recently been weakened.
The Office of National Statistics has finally worked out how much in pension obligations the government has committed itself to (as of the end of 2010): £5.0 trillion - that is a '5' followed by twelve zeros (£5,000,000,000,000).
Of this £5.0 trillion, £3.8 trillion were in respect of state pensions (representing 263% of GDP), which by definition are 'unfunded' (i.e. they must come out of general taxation income). Obligations relating to unfunded pensions for public sector employees in the UK were estimated at £0.9 trillion (58% of GDP). So the unfunded government obligations amount to £4.7 trillion (or over three times the annual output of the UK economy).
As far as I can make out from the report, this does not include additional benefits for pensioners, such as pension credit.
To quote the more detailed report: "Pension liabilities do not represent debt in that they do not constitute previous borrowing which has to be serviced or ultimately repaid. However, they are liabilities in the sense that they represent the obligations outstanding implied by current pension rules and legislation. In the case of unfunded pensions which are the responsibility of government, these obligations need to be met out of future revenues and receipts."
Surprisingly, the UK's position does not seem to be unusual by EU standards - but that is a lot of money to find from somewhere, not just here but Europe-wide.
A further £2.1 trillion of obligations have been built up by the UK private sector. The private pension landscape in the UK is a bit more complex: the following illustration from the report helps to clarify this.
As most readers will be aware, there are two main types of private pension:
- Defined benefit (DB) pension schemes are those in which the rules specify the rate of benefits to be paid. The most common DB scheme is one in which the benefits are based on the number of years of pensionable service, the accrual rate and final salary. However, Career Average Revalued Earnings (CARE) schemes are becoming increasingly common in the UK. These base the pension on earnings over the whole career, adjusted by prices or earnings.
- Defined contribution (DC) pension schemes are those in which the benefits are determined by the contributions paid into the scheme, the investment return on those contributions (less charges), and any annuity purchased on retirement. They are also known as money purchase schemes.
Proportionately, much more of the private sector pension obligation is funded but some is tied up in partially-unfunded 'final salary' pensions that rely on annual 'top-ups' from the employers. What is more, QE or quantitative easing appears to have quadrupled the pension deficit of FTSE350 companies in the space of 12 months. This rise in pension deficit has been primarily due to falling gilt yields, which in turn has slowed the growth of the companies' pension pots. Gilt yields have reached historically low levels because the Government bought a third of the gilt market through QE. Paying for these obligations could act as a drag on company finances for decades, handicapping returns to shareholders and depressing the UK stock market.
The moral has to be: don't rely on the government or your employer to fund your retirement - as far as you can, make your own arrangements. For most people, this will require years of consistent economising, saving and wise investing.
The second observation is that UK (and EU) companies face a strong headwind in funding their pensions obligations. This is likely to depress stock market returns for decades.
Where's the money going to come from for the public sector pensions? It's got to be a combination of higher taxation, later retirement ages (delaying the eligibility for State pensions) and lower benefits (by allowing inflation to erode the value of the benefits).
So build up your tax-protected savings as much as you can and don't count on much from your State pension. And maybe look look at your portfolio to limit how much is in equities, rather than fixed-income.
I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.
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