Mark Wood talks about how people just don’t ‘get’ inflation and the five actions that therefore need to happen to ensure decent retirement provision

The September inflation figures are perhaps the most significant of the year, in that benefits and pension entitlements are for many beneficiaries driven by the published figure. The rate of inflation will be reported to have dropped dramatically. This will be puzzling for many people, and particularly pensioners. Week by week prices rise and yet the official numbers show a decline. The basket of goods which feeds the index includes some quite significant items we only occasionally buy and indeed some have recently argued the method by which the index is calculated tends to understate the rate at which the index is represented as rising. This is important, particularly at the moment. In a period of austerity people don’t tend to splash out on wide screen televisions. They only spend on the essentials. While the price of oil may be off somewhat, the price of oil-based products including fuel and petrol tends to lag behind the movements in the price of the unrefined raw material. At the same time a disastrously poor harvest in a wide range of crops right around the globe is already pushing up prices. Perversely a poor harvest accelerates price rises as the value of existing stocks rises.

More important than all of this though is the fact that, in general, our instinctive appreciation of the effect of inflation over the long term is limited to our satisfaction at the rate at which the value of our homes rises. This though is of course only to our benefit when we cash in, which is most often when we downsize in retirement. Research suggests that many of us then fall into a trap. We spend the money. Tax free cash reduces future pension income; a flat or ‘level’ pension reduces future ‘real’ income. Yet the vast majority of people elect to take cash from their pension pot at the outset of their retirement and to sign up for a level pension when they annuitise their DC monies. We don’t ‘get’ inflation. Consequently when we receive our statement of future pension entitlement the numbers are broadly meaningless as they are inflated by including an allowance for future inflation.

Among our recent recommendations in our white paper, The Future For Pensions in the UK, are:

1. Saving will need to become compulsory
Increased levels of savings will be required; the 2017 review of auto-enrolment should begin to consider increases to minimum contributions whilst, in the 2022 review, compulsion should replace auto-enrolment and mandatory increases to contributions will be necessary to achieve the Pensions Commission’s recommended income replacement rates.

2. Early increase of the State Pension Age to 70 initially, then further over time
The retirement age to which individuals aspire must reflect the substantial improvements in life expectancy, the true extent of which have only recently been appreciated. Longer lives must translate into longer working lives.

3. Getting DC right is an imperative
If the future of workplace pensions is DC then we have to get it right by encouraging much better engagement with members and using technology to bring DC ‘alive’ and promote behavioural change.

4. Pension projections should be quoted net of inflation and NI relief for employee contributions should be introduced
There needs to be a significant improvement in understanding of finance and pensions. A practical first step would be the presentation of all financial projections relating to pensions in today’s values (net of an allowance for inflation). Also, National Insurance should not be charged on income set aside for pension provision.

5. The Open Market Option should become compulsory to allow for the maximum return on savings at retirement In association with The Aon Hewitt Risk Settlement Team was lead adviser to over £4 billion of buy-ins and longevity swaps in 2011.

Written by Mark Wood, non-executive chairman at JLT

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