As if it weren’t already hard enough to get people to give up instant gratification to save for their retirement, pension illustrations come with a piece of absolute hocus pocus surely designed to finish the job of putting people off: E.o.C. or Effect of Charges. What other product producers are obliged to try quite so hard to put off their customers – aside perhaps from cigarettes. Pensions, of course, aren’t imbued with powerful addictive properties …
Imagine if other products came with effect of charges calculations – say, cars. First you’d have to assume that the money spent on the car would instead have been invested and grown by 7% per annum, compound. You’d have to take account of annual insurance, road tax, servicing and petrol costs too. And you’d have to assume that all these costs would also have been invested and grown by 7% p.a.
In fact, I did my own highly unscientific calculations (using a pension illustration engine – nice ironic touch, eh?) and estimated that on a ten year basis an effect of charges calculation on a £15,000 car could easily show it costing over 3 times that amount! I don’t think any car showroom sales people will be suggesting to their prospective customers that the shiny new £15,000 car they are admiring will really cost them well over £45,000!
You could do the same with so many products – how about a washing machine, say? Add in the cost of metered water, electricity, powder, fabric softener, maybe an occasional breakdown, even a contribution to your home contents insurance premiums. Hey presto: the price is instantly transformed into something that looks distinctly alarming.
At least with a car or a washing machine you get some immediate utility: you need to go places today or you’ve got clothes that need washing now. Pressing needs might mean these goods would survive an Enormous Obstacle to Consumption. With a pension, it’s a very different matter. The cost of contributing, say, £300 p.m. is immediately obvious and consumers can quantify and relate to it 100%. On the other hand, the utility – the income in retirement – is generally too far off to imagine or relate to, very difficult to quantify and fraught with uncertainties. Then someone insists on calculating an Enormous Obstacle to Contributions!
Having recently been reminded that by far the most significant influence on income in retirement is pension contributions, not investment returns or charges, and having seen the figures in the trade press recently showing how many have ceased making pension contributions, I suggest these calculations on their head to a constructive purpose.
When someone proposes cutting their pension contributions – or when a company pension scheme member proposes contributing at less than the maximum rate attracting matching employer contributions – this should trigger an Endeavour to Obviate Cuts calculation. What might those non-contributions grow to over time? Having some extra money in the bank might seem rather attractive when money is tight and the annual holiday is on the block. To help balance the decision, people need to understand what they are sacrificing.
Taking the hypothetical £300p.m. contribution above (net personal) and assuming our hypothetical member is, say, ten years from their intended retirement date, an Endeavour to Obviate Cuts calculation showing that this cut in contributions might be expected to cost them the best part of £55k in pension fund value – or something like £2,700 in income for the rest of their life – would bring it to life for them. It might tap into their natural aversion to losses and balance the very human preference for immediate gratification. Isn’t that the sort of stuff policy makers are supposed to encourage?
Note: the calculations in this blog are approximate and all figures are for the purposes of this blog only.