Serious MoneyHeeding the obvious may pave the way for a more comfortable retirement, writes Chris Johns
Retirement planning is boring, yet its importance cannot be denied. Hence, the outpouring of advice that, in the US at least, means books on "strategies for a successful and early retirement" often reach the best-selling lists.
A recent example of the genre is contained in Walter Updegrave's new book We're Not in Kansas Anymore: Strategies for Retiring Rich In A Totally Changed World, where the author reveals the 10 key steps necessary to accumulate a nest egg of sufficient size to support anyone through retirement.
The slightly enigmatic title is intended to convey the impression that we live under such dramatically changed circumstances that we can no longer rely on corporate benevolence and government largesse to provide for us in old age.
Such books always overstate their case. Pension provisioning for earlier generations was rarely as generous as the authors seem to suggest and the only thing that has changed that should alter our retirement expectations is that we are living longer.
The pension systems that are so obviously creaking were all designed for people who were never meant to live much past retirement; the benchmark retirement age of 65 was an original invention of Bismarck, who put it in place when life expectancy was 48 years. The actuaries of the day thought that system was extremely well designed.
Updegrave's first step of his 10 key ideas - so presumably this is his deepest insight - is that we should "begin saving as early as we can". Wow! No wonder people find something else to do when they read this kind of stuff.
But if advice like this is banal it is also important to remember that it is absolutely right. Because most people switch off at this point they fail to appreciate just how deep the pension problem actually is and how little chance most of us now have of actually saving enough to fund a healthy pension.
We also discover just how valuable (i.e. costly to the taxpayer) are public sector pensions. It's all about arithmetic of course, which is another reason why many people choose to ignore some pretty profound truths.
The arithmetic might be simple but any answer depends on some key assumptions: how much we contribute year by year, the investment return we obtain and the prevailing annuity rates at the time of retirement (this tells us the size of the pension our savings pot will buy).
For example, assume that a hypothetical private sector worker starts salting away 10 per cent of his total income at the age of 21, achieves a real (after inflation) return of 3 per cent (a conservative although realistic assumption) and annuity rates are similar to the ones he can get today. In such circumstances he will not save enough to achieve a two-thirds final salary pension that somebody starting at the same time in a civil service pension will get on retirement, probably before 65.
Luckily, our private sector worker's pension won't be too far under the magic two-thirds level.
But how many people have the wisdom and spare cash to save a whopping 10 per cent of their income from their early 20s? And how many 21-year-olds want to work until they are 65? The only reason our forward-thinking saver achieves a near-decent pension is a high contribution rate maintained for nearly half a century.
If we start to save later and we wish to retire early, we don't stand a chance. If our imaginary saver puts off starting a pension until he is 30 and aims to retire at 60 he will struggle to achieve a pension of one-third his final salary. Hence the advice to start early and the need to appreciate the finer points of compound interest.
Every single piece of pension advice that anybody receives has to confront these basic facts, derived from spending 10 minutes with a calculator. Anybody in their 50s usually knows all about the finer points of annuities; people in their 20s ignore such arcane details at their peril. The problems with annuity purchase have led governments in the Republic and Britain to fiddle with the rules such that there are now other ways of tapping into the savings pot; but none of these rule changes alter the fundamental picture.
The advisers tell us that all is not lost, however. If we are falling short of our goals we can save more (key step number four of Updegrave's 10 steps).
Again, this statement of the blindingly obvious should not obscure a deeper truth: either save more, work beyond the age of 65 (key step six, incidentally) or have a poor retirement.
There is, quite literally, no other alternative (other than getting lucky with your investments or by working for the government).
The relentless nature of the arithmetic has led many - perhaps most - companies to close their defined-benefit schemes, which, like their public sector cousins, were designed to be paid to people who lived for only two or three years after retirement. Where shareholders have led, governments will follow: I am willing to bet that today's young public sector workers are not going to get anything like the pensions that they think they have been promised.
As people live longer, annuity rates will continue to fall and we will have to save even more to achieve a given pension. Ultimately, early retirement will be only for the super-rich.
Pension equilibrium will be restored when they are paid to people for only the last few years of their lives. Forget about early retirement: that will be for the lucky few.
Changes in pension law and greater sophistication will mean that more people take charge of their own savings and retirement planning. Where the US has led, the rest of us will follow.
More and more books with 10 key steps will be written (by people trying to boost their own pension pots). But the arithmetic won't change.
Hopefully, people who write columns about investing will be in much demand.
