Imagine if I offered you the following investment:

• For every $100 you invest, you will receive back $159 every year until the day you die
• The amounts will be guaranteed by the government so it is a ‘risk-free’ investment
• As a bonus, the $159 will be increased by 2.5% each year that you receive it
• As a further bonus,if consumer prices, or wages increase by a rate higher than 2.5% your $159 will be increased by the higher of the consumer price increase or wage increase (whichever is higher)
• These increases will happen every year

Are you biting off my arm yet?

Can you get more boring?

In my previous posts, I talked about some of my ‘speculative’ investments which, truth be told, I do not consider too risky given the potential returns.

It is ironic then that this investment, although backed by the UK government and having fantastic returns, is perhaps the investment that I am most pessimistic about yielding a positive return.

You see, the investment I am talking about is the UK’s New State Pension.

After 35 full years of contribution, you would be entitled to a weekly pension of £164.35 for the rest of your life once you hit the age of 67.

So what are the problems with this investment:

• As with many social security schemes, the #1 enemy is demographics. The pension age was previously set not far off from the average life expectancy thereby giving a net years payable of zero. Increasing life expectancy is putting a heavy burden on social security systems.
• On top of that, the aging population means fewer workers contributing to the pension scheme and more pensioners claiming from it. In 1976, 61% of the population was aged 16-64 and 14% aged over 65. By 2046 this is expected to be 57% and 25%.
• Indexing the benefit by the greater of 2.5%, earnings inflation or consumer price inflation is insanely generous and completely unsustainable. This will inevitably need to be addressed but it would be a brave politician who throws himself onto this political grenade.

What this means is that:

• Benefits must be delayed;
• Benefits must be reduced;
• The amount paid in by workers will need to increase; and/or
• Some combination of the above.

We can see that some of this is already happening: retirement age is already increasing and I suspect will continue to do so. Pension Credit tapering also reduces the cost to the government (but maybe with the side-effect of dis-incentivising savings).

It hasn’t happened yet, but I believe the generous indexing will need to be reduced or eliminated. The worse thing for me personally would be if the actual pension benefit itself were to be means-tested and that I receive nothing as a ‘rich’ pensioner.

Even with these risks, I am happy to pay into this pension scheme not as an investment, but rather as an insurance (if I lose everything else, I will have the pension to fall back on).

Those familiar with the UK pension scheme may notice one particular thing doesn’t seem to make sense, but I will address that in a future post!