OpinionDec 22 2016

Jam tomorrow? More like stuck in a jam today

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Rising prices aren’t just something we all feel – they’re a raw electoral nerve and a key vote-winner or loser.

They’re also a key issue for the government’s demographic du jour – the Jams, Britain’s army of hard-working folk who are 'just about managing'.

JAMs are the people who stand to lose most from high inflation and low real wage growth. They tend to spend a higher proportion of their earnings on basics like food and fuel, and are set to see their standard of living fall steadily as price rises outstrip wage rises.

Unsurprisingly, they’re also the least likely to be saving into a pension. It’s hard to save for jam tomorrow when you’re struggling to put bread on the table today.

With consumer inflation still hovering around 1 per cent, the full inflationary impact of sterling’s abrupt fall this year has yet to be felt. But the cheque is most definitely in the post – and the economic think-tank NIESR predicts inflation will hit 4 per cent next year.

The regulator’s bearish rules finally seem less out of kilter with inflationary reality but that doesn’t make them any less onerous.

While no investor will be cheering the prospect of such a big jump in inflation, the FCA could be forgiven for breathing a quiet sigh of relief, as IFAs may finally cut it some slack over its extraordinarily bearish rules on pension projections.

As any adviser who has walked a baffled client through a pension projection which suggests negative net returns will know, when producing a forecast pension providers must assume an inflation rate of 2.5 per cent.

When the requirement was introduced in April 2014, the FCA’s assumption of perpetual 2.5 per cent inflation struck many as unnecessarily bearish – especially as the lowest assumed rate of pension growth was set at just 2 per cent for equity-based investments.

Two and a half years on, and the regulator’s bearish rules finally seem less out of kilter with inflationary reality. But that doesn’t make them any less onerous, or unhelpful – either for advisers or clients.

No-one would argue with the need to factor inflation into long-term financial planning. The trouble is the inconsistency in the way pension providers are doing it under the current FCA rules on pension projections.

With different providers calculating their pension projections in wildly different ways, it’s almost impossible for advisers – and their clients – to compare like with like, let alone get a clear idea of what their pot will be worth when they retire.

If one provider uses a 3.5 per cent mid-growth rate for corporate bonds and the other one uses a 3 per cent mid rate, it doesn’t take a rocket scientist to work out that there will be a large difference in the final projection. This variance could mask a difference in fees.

Pension illustrations are typically explained to the client by their financial adviser, and a good adviser will be able to spot these differences.

But the rise in robo-advice services targeting the advice-gap could cause issues. If one robo-adviser shows their medium risk portfolio growing by 4 per cent and another shows a rate of 4.2 per cent, clients might not spot this subtle but important difference. 

To make matters even more baffling, Isa projections do not need to factor in inflation, which risks tempting people into using Isas as an alternative to pensions.

The FCA has a duty to ensure clients are given the full facts, and an understanding of the impact of inflation is an essential part of this.

But it also needs to balance transparency and clarity with encouraging people to save. At present that balance isn’t right.

Even with inflation set to rise, the FCA’s requirement that projections assume a lifetime average inflation rate of 2.5 per cent is unduly negative – and there’s a risk that it may even put some people off pension saving altogether.

Jams whose real wages are falling and are barely making ends meet often need plenty of persuasion to save for their retirement. Auto-enrolment may give them a nudge to start, but if their pension projection shows inflation exceeding their returns, some might abandon the pensions habit. 

But if the inflation assumptions risk being counterproductive, the lack of a single methodology for calculating projections is frankly baffling.

When providers select their own growth rate, you’re always going to have differences. Would it not make sense to have an industry standard so that illustrations can then be used to compare charges?

The mid growth rates can then be reviewed periodically according to market conditions – much as we use current gilt yields for capped drawdown.  

The FCA and the pensions industry should work together to clear up this ridiculous anomaly, and agree simple and clear rules on how projections are calculated.

Matthew Rankine is a director at Liberty Sipp.