Should I be worried about my pension?

This is an audio transcript of the Money Clinic podcast episode: ‘Should I be worried about my pension?’

Claer Barrett
You know things are really kicking off in the pensions industry when it ropes in the grime music star Big Zuu to send out a message.

[‘PAY YOUR PENSION SOME ATTENTION’ BY BIG ZUU PLAYING]

Big Zuu performing ‘Pay Your Pension Some Attention’
I never thought when I was a young youte sitting in detention. That I’ll be talking about pensions . . .

Claer Barrett
It’s not just Big Zuu, though. The last few weeks have seen the Bank of England ride to the rescue of pension funds. And Liz Truss, while she’s still prime minister, felt the need to reassure older people that they’d get an uplift to the state pension. The thing is, pensions don’t usually make the headlines. So what’s all the recent fuss about? And how worried should we all be?

[MUSIC PLAYING]

Welcome to Money Clinic from the Financial Times. The podcast about personal finance and investing. I’m Claer Barrett, the FT’s consumer editor.

You might have thought the market turmoil of the past few weeks only affected wealthy investors or traders staring at screens in the City of London. But actually, the fallout has been much broader. We’ve all seen what’s happened with mortgage interest rates. And if you’re paying into a pension, volatile markets could have a direct impact on the ultimate value of your retirement fund. But it’s important not to panic. In this episode, we’ll explain why and give you some tips on how to deal with rising levels of pension tension. As ever, Money Clinic isn’t offering financial advice. You need to do your own research so you can make your own informed choices.

But for now, let’s meet our guests. Please introduce yourselves to our listeners, starting with you, Jo.

Josephine Cumbo
Hello, I’m Jo Cumbo, the FT’s global pensions correspondent.

Claer Barrett
And David?

David Hearne
Hello, I’m David Hearne. I’m a chartered and certified financial planner for Financial Planning Partners in Berkshire.

Claer Barrett
Well, thanks for joining me and welcome to the show. And thank you for accepting the challenge of helping our listeners understand what’s going on in the world of pensions. Now, these headlines sound worrying. But David, before we unpick the details, do you have any messages of reassurance for listeners to cling on to?

David Hearne
Yes. The key message is that for most people, pensions absolutely remain the best way to save for retirement. And for most people saving regularly, actually these periods of volatility can be a good thing because any regular contributions are buying investments each month at a lower price than they might otherwise have been.

Claer Barrett
And Jo, what could you offer to listeners to reassure them about what’s been going on?

Josephine Cumbo
Those headlines of the recent weeks, Claer, yes, they’ve been quite scary. With talk of pensions collapsing, that might have made people very nervous about pensions and opening a pension or keeping their pension. We’re going to talk you through this over the next 25 minutes and explain what you need to know.

Claer Barrett
Well, fantastic. Now, before we go any further, let’s press the rewind button and get some basics sorted out. Now, the word “gilt” has been in the news an awful lot in the last few weeks. David, what is a gilt? And could you tell us what have gilt got to do with pensions?

David Hearne
So a gilt is specifically a government bond in the UK. That’s the name we give them. In the US they are called Treasuries. And a government bond or a corporate bond is how governments and companies borrow money to fund the spending plans they have or the factories they might want to build if they’re a company. Now, if you own a gilt, then the UK government owes you money. And like any loan, that gilt has a term when that loan must be repaid and it has an interest rate that must be paid to you each year. Pension funds, particularly defined benefit pension funds, tend to buy gilts because they can use the regular stream of interest payments that they receive in order to pay out the pensions to their pensioners.

Claer Barrett
OK. Well, a little further lesson here. There are two main types of company pension when you have your pension with your workplace. Gilts tend to be a bigger feature of the more old-fashioned and generous sorts of pension, sometimes described as final salary or defined benefit pensions, although younger listeners are perhaps less likely to have one.

David Hearne
The biggest difference in the two main types of occupational pensions is certainty. A defined benefit pension is based on your final or average salary, and when you retire, it will pay you a fixed income, and it will pay you that until the day you die. The alternative is what’s called a defined contribution pension, which is where you build up a pot of money. But you face the uncertainty then of how it’s invested, how that performs, and then how you draw income from it when you retire. And most importantly, whether there’s enough money there to last for the rest of your life.

Claer Barrett
OK. We’ll come back to defined contribution pensions in a moment as they’re the type that most listeners will actually have. But first of all, a quick recap of what happened to gilts. Now, the real damage to government bonds occurred in the wake of the “mini” Budget when former chancellor Kwasi Kwarteng said he’d make billions of pounds worth of tax cuts. Jo, talk us through what happened next. 

Josephine Cumbo
Yes, Claer. On September 23rd, Kwasi Kwarteng announced £45bn of unfunded tax cuts. And crucially, he planned to increase government borrowing to pay for them and the much bigger cost of supporting households through the coming winter’s energy crisis. Now, the markets did not like this at all. The pound slumped and gilts rose sharply as investors demanded a bigger reward for lending to a government whose fiscal credibility was now being questioned.

Claer Barrett
Thanks for that, Jo. OK. Now, buckle up for some more explanation. That spike in gilt pricing had an immediate knock-on effect for some final salary pension schemes that at least complicated hedging contracts called LDIs. Now, you don’t need to understand exactly how they work, but sudden changes to gilt prices had one big problematic effect. All of a sudden, those pension funds needed to find more cash to cover their growing liabilities. Banks started making so-called margin calls as a polite way of saying, “Hang on a minute, we need some more money from you and we need it now”. And to raise that cash, these funds all needed to sell assets like gilts, perhaps, which then cause more problems. Jo? 

Josephine Cumbo
It created something called a “doom loop”, which created the liquidity crisis... 

Claer Barrett
A cash flow crisis, in other words.

Josephine Cumbo
. . . at which point the Bank of England had to step in because there was a risk if these pension funds couldn’t meet their margin calls, that it would have a knock-on effect to the LDI managers and then on to the banks and then on to the wider financial system. So what the bank did was step in with a bond-buying programme to create a market, to buy bonds, to create some liquidity for the pension funds, to actually meet their margin calls. And, and it did work. We had . . . Some stability was restored to the markets.

Claer Barrett
Now, David, these hedging arrangements that the pension funds had in place to ensure against fluctuations in the price of government bonds — LDIs. Most people — I admit, including me — have never heard of an LDI a month ago, but in fact their use is really widespread.

David Hearne
Yes, that is. And a reminder for those that are members of a defined benefit pension, they shouldn’t have to worry about the internal investment strategies of those schemes because they are entitled to their benefits. Then it’s up to the trustees of the scheme about how they manage their own assets, and if they don’t manage them well enough, or if there’s ever a shortfall, then it’s up to the the sponsoring employer to plug that shortfall.

[MUSIC PLAYING]

Claer Barrett
OK. Great explainer of what’s been happening. But now we’re going to relate all of this to what it actually means for our money. Now, Jo, for listeners who are lucky enough to be a member of one of those generous final salary pension schemes, what could the future hold for them? Will be schemes carry on paying out pensions in the future?

Josephine Cumbo
Thanks, Claer. You know, setting aside the drama of the past few weeks with these LDI contracts, the general news is that DB pension scheme funding is much better than it has been for many, many years. And I know it might be difficult to marry those two concepts after what has happened in recent weeks. But yes, generally these schemes are in much better health. And the reason for that is that when interest rates rise, it’s good news for DB schemes because of the way their liabilities are valued. So what this means is that if you were a member of one of these schemes, that the overall fund position is much improved, which should mean, you know, it’s much better. Because at the end of the day, it’s the employer who provides the backstop for this fund. If they go insolvent, you could end up in the Pension Protection Fund, which is in the bad place to be because you will have your compensation paid. But the good news is the better funded that these schemes are, the less stress it places on the employer in terms of paying contributions.

Claer Barrett
Yeah, known as the Pensions Lifeboat. It’s come out to the rescue a couple of times when companies like Debenhams have collapsed. Very, very rare thing. But in the round, people with final salary schemes are looking pretty safe. Now, David, let’s talk about most of us, me included, who have the less generous type of company pension scheme, a so-called defined contribution or DC pension, where we pay in money throughout our working lives, and then we get a pot of money at the end that we have to decide what to do with. Now, how have DC pensions been affected by the upset in the gilt markets? And what do listeners need to look out for?

David Hearne
Yes, same for me. I have a defined contribution pension. And if they . . . Whether somebody has been affected by the turmoil and the gilt market would depend on how many gilts they hold in their pension fund.

Claer Barrett
Mmm-hmm.

David Hearne
So many schemes . . . Many of us will be invested in defined contribution schemes that automatically do something called “lifestyling”, which gradually reduce the amount of money in your pension invested in equities, and increase the amount invested in gilts and bonds. So that in the ten years until retirement, you may be moved from 100 per cent in equities and end up 100 per cent in gilts and cash. And this is why it’s so important for people to check the retirement age on their pensions, because if they are invested in a lifestyle strategy, the age that they’re set to retire will depend on the age and the lifestyling starts. And I’m very conscious that there will be people out there who, when they were, say, 25 and first signing up for their pension retirement seemed a long way off and in their ambitiousness may have chosen a retirement age of, say, 55, which could mean that their being lifestyled from age 45 and moved out of the stock market, out of high-return assets. And so they don’t retire until they’re, say, 65. It could be that they’ve got a decade or more out of the stock market missing out on the higher expected returns, sat in gilts and cash, even though they might not be expecting to buy an annuity for five or ten more years. So it’s very important that people check that the age on their pension scheme, and also whether they are in a lifestyling strategy.

Claer Barrett
How can they go about checking that? Bearing in mind that we might not just have one company pension, we might have ones from old jobs that are mouldering away in those A4 envelopes, in drawers, you know, houses.

David Hearne
Yeah, I’m afraid it involves a bit of work, but this is where it’s important and valuable work to do for the sake of your future self. It’s important to envisage 70-year-old giving you a tap on the shoulder and saying, “Hey, look out for me and remember that this is your pension”. And that uncertainty I mentioned earlier is yours, and you will either gain or benefit from the decisions you make. When a company chooses a pension provider, there might be 10,000 members in that scheme. And so when it chooses a default investment fund or an automatic lifestyle strategy, it doesn’t know who you are. It’s just doing what it thinks is best for the average employee in that company.

Claer Barrett
And just to add a bit of context here, more than 90 per cent of us in a workplace pension are in that plain vanilla default fund.

David Hearne
Now, that might be fine when you’re in your 20s and 30s. You’re perhaps just accumulating the money. But certainly when you’re in your 40s and 50s, and the pot’s getting bigger and retirement’s getting nearer, it’s really important to go and check those things and to make sure that the pension is for you and you just don’t sit in the same pension as 10,000 other people because it might not be what you plan to do.

[‘PAY YOUR PENSION SOME ATTENTION’ BY BIG ZUU PLAYING]

Big Zuu performing ‘Pay Your Pension Some Attention’
Invest in yourself later you will have the protection. All I’m tryna say is think. If you make that link . . .

Claer Barrett
Now, Jo, I know that you worry. All of these negative headlines are causing people to pay the wrong sort of attention to their pension. There’s lots of stories in the FT and elsewhere about younger people, with a cost of living crisis, opting out of their workplace pensions, or maybe fiddling around with their funds because they’ve seen the news and are worried about the risk of pensions and think maybe it’s not for them.

Josephine Cumbo
Claer, you’re right. I do feel for the younger generation. Currently, if you’ve been automatically enrolled into a workplace pension, your employer must pay at least 3 per cent of your pensionable salary towards the pension. But some and many employers do pay much more than this. But if you opt out of your pension plan, then the employer is not obliged to pay your contribution to you. So you risk losing that free money and effective you opt out. It is a pay cut and once you opt out, you also lose tax perks on those pension contributions. So I totally get why some young people may want to opt out to save money if they’re struggling with bills or they want to save for a home or pay extra towards the mortgage. But I do think that anyone should think very carefully about what they’re giving up, if they do opt out and how this will impact them in the long-term.

Claer Barrett
Mmm. Well said, Jo. And David, you’ve heard the Big Zuu campaign. What do you make of it?

David Hearne
I share Jo’s concerns about people opting out. The only encouragement I would say is to: Please don’t. Unless you’re absolutely sure that that’s in your best interest. If you have long periods opted out or if you opt out for a year, but then don’t go back in because you’ve got used to the the higher income, there’s a real risk that you’re putting your your future retirement in jeopardy. So just because you can opt out doesn’t mean you should. And if you can find savings elsewhere, then all the better. Because as Jo said, you’re not just giving up your pension contribution. You’re giving up the contribution from your employer, the tax relief from the government and the future compounded growth that you would otherwise benefit from.

Claer Barrett
Yeah, much, much more at risk than just getting a bit more money in your salary. However, one company that’s been in the news recently is Deloitte, the Big Four accountancy firm. Now they’ve offered their 22,000 UK staff the chance to take that employer’s contribution as cash in their salary during the cost of living crisis, because they think that their staff need more flexibility with their finances and are capable of choosing what’s best for them. More money in your pay pocket or more money in your pension in the future. Jo, what do you think about that?

Josephine Cumbo
I am a little bit concerned about where this might lead to. Because my concern is if that other companies start to follow Deloitte, because Deloitte might be seen to be more competitive because it’s offering this flexibility and that their wages might be a little bit higher. If you can take the pensioners’ cash in the salary that people won’t engage, they won’t top back in after a year because something will always come up. One-third of it’s not paying off bills, it could be saving up for a holiday. And that will mean that it becomes a lot harder in the long run for that individual to start saving adequately for retirement. We already have a pension adequacy crisis in this country, so things could become a lot worse if that pension isn’t prioritised at an early stage.

Claer Barrett
And opting out of your pension could be of particular appeal for young people. We get lots of questions from listeners saying, “Should I save into a pension or save up for a property instead?” That’s a very big challenge for them financially to do. Dave, what are your, what are your thoughts about that?

David Hearne
That’s an obvious question to ask. And when you’re young and first starting out, your pay isn’t yet maybe what it will become and you are faced with these tough choices. The only thing I would suggest is that you are auto-enrolled typically by your employer into a pension. And as we touched on earlier, you wouldn’t want to miss out on that. And although the bedrock of most people’s financial security is owning a home, I’m not sure that that is security if it comes at the expense of having a pension. And when it comes to planning your finances out in your life, if the only way you can afford a home is by not having a pension, then I’m afraid that perhaps you’re either not able to buy that home or you need to reconsider where you’re going to buy a home or how much you might need to earn in future. And I often think I know it’s easy to say, but the best investment is to increase your income because the more you can increase your income, the more money will go into your pension and the more you can then save and then ultimately borrow against that income.

Claer Barrett
Mmm. And anyone who’s looking to increase their income, don’t forget our most popular episode of the year is How to ask for a pay rise — and get one. It’s there in our past episodes. Finally, yet another type of pension — the state pension — has been in the news this week because of the “triple lock”. Now, this is the government’s promise that the pension that you get when you reach the age of 67, the government will increase in line with either inflation, how much average earnings are rising by or 2.5 per cent, whichever is the higher. Now, this week’s inflation figure was just over 10 per cent. So if the state pension goes up by that much next year, that’s going to take it to more than £10,000 a year for the first time. David, obviously, a huge cost to uplifting the state pension. But pensioners tend to be the ones who vote. So this week we had some interesting news about what might happen in the future.

David Hearne
Yes. And I think that’s partly the trouble with politics and pensions, is that I would love pension policy to be made decades in advance without people worrying about their . . . whether they’re about to resign as prime minister or be reelected in a future election. The state pension is an enormous bill for our country and whilst I think we would all want it to increase with inflation, and particularly for those that rely on the state pension, it is not sustainable in its current form. And so we face difficult questions about if we want to maintain the amount and we want it to stay linked to inflation, then do we need to continue or even accelerate the increases to the age when it is paid? And we need to have these tough discussions as a country and our politicians to do so in a grown-up way because we cannot just keep increasing the cost of the state pension when we know that there is a smaller generation following. The number of children families have now is smaller. And so we are supporting a larger population of pensioners than at any time in the past. And whilst absolutely we should be paying the state pension promises that have been made, we can’t let that all fall on the shoulders of one generation who may themselves face much, much later retirement ages.

Claer Barrett
Mmm-hmm. Well, quite, and the fact that the state pension goes to everybody. You could be a millionaire and still get the state pension or you could be somebody on the breadlines is another thing that’s really coming under scrutiny. A topic for another day, perhaps. Now finally, both Jo and David, do you have any parting tips for listeners about their pensions? Starting with Jo.

Josephine Cumbo
I have three points I just like to make Claer. Most people are not saving enough for retirement and they’re not aware that they’re not saving enough. So you need to bear that in mind. Appreciate the benefits of pensions in terms of those contributions, the free money from your employer and the tax benefits of starting early, the effect of compounding on that pension, of getting the money in early. And finally, I would just say to think very carefully about what you are giving up when you opt out of a pension.

Claer Barrett
Brilliant. Thank you, Jo. David, how about you? Any parting tips?

David Hearne
Yeah, I agree completely with Jo that a lot of people are saving into a pension, but may not be aware that it’s not enough. And it’s important that if you are saving into a pension, that you make sure you are fully maximising any matching opportunities that your employer gives you. I think for those that are in pensions and maybe those that are wondering whether they should stay in them or opt out, we talked about the benefit of staying the course. And whether it’s this crisis or the recent Covid crisis, or the credit crisis, or the tech crisis, there will always be something in the world that will have an impact to your pensions. But unless you’re retiring in the next couple of years, you should be able to see that through. And if you continue saving, you should benefit from that in the end.

Claer Barrett
So keep calm and carry on. And if you do one thing, go into work and find out what the level of employer matching is on those contributions. What is the free money that you should be getting? Everybody wants a pay rise at the moment, but getting more from your pension is probably the easiest way of getting one.

[MUSIC PLAYING]

Well, that’s it for Money Clinic this week, and we hope you like what you’ve heard. If you do, please leave us a review. And if you’d like to chat with me on a future episode of the show, then get in touch. Our email address is money@ft.com or send me a DM on social media: I’m @ClaerB.

[MUSIC PLAYING]

Money Clinic was produced by Persis Love and Philippa Goodrich. Our executive producer is Manuela Saragosa. Our sound engineer is Breen Turner, and the original music is by Metaphor Music. And finally, as I said earlier, the Money Clinic is a general discussion around financial topics and does not constitute investment recommendations or individual financial advice. For that, you’ll need to find an independent financial adviser. That’s the small print over and done with. See you back here soon. And in the meantime, don’t forget to pay your pension some attention.

[‘PAY YOUR PENSION SOME ATTENTION’ BY BIG ZUU PLAYING]

Big Zuu performing ‘Pay Your Pension Some Attention’
You gotta pay your pension some attention. (Hello!) I try put the young Gs in the right direction. Let’s change the perception. It’s alright for you to ask questions.  (“That is so dope. Haha! I’m done. I’m finished, guys!”)