Why it pays to be negative about your pension

As the FSA forces pension projections down, we look at why this is a good move and how to boost your own pension prospects.

After a long period of research and reflection, the Financial Services Authority (FSA) has decided that pension companies must lower the projections they show customers. These projections tell pension savers how much their pots might grow over 10-15 years.

Pension providers must show three headline projections, representing a poor-case, an intermediate-case and a best-case scenario. Currently, the lower projection is 5%, the medium one is 7% and the top one is 9%.

Although these numbers might seem low to you, at the medium rate, £10,000 invested today would turn into £55,000 after 25 years.

Providers have an inordinately long time – until April 2014 – to lower their projections to the new rates of 2%, 5% and 8%.

Current and new pension projection rates

If you achieve the new medium rate over 25 years, you would turn your pot into less than £35,000.

These projections are not lowered to take inflation into account. Nor do they take into account any costs that apply to your specific pension plan, or any future costs, such as those you'll incur when you start taking a retirement income from it. So in reality you could expect considerably less if these projections were to come true.

Too late, too much, or just right?

It's interesting to see the different opinions about these projection changes.

The Investor, who writes a mean investment blog on the Monevator website, takes the view that the FSA is closing the stable door after it has bolted, and he believes shares are due a very big run.

The regulator, he says, has rolled up shortly after a decade or two of poor returns to warn us to temper our expectations: “As far as useful advice goes, this is a bit like Eva Braun showing up in London in the middle of the Blitz to warn Churchill that her boyfriend seems somewhat obsessed with guns.”

He goes on to ask where the regulator's warning was back in the dotcom bubble, when companies were selling for a massively inflated 30 times their earnings, on average.

You might even lose money

It's unsurprising that pension provider LV=, complains that the reductions have gone too far.

John Perks is the retirement solutions managing director at LV=, heading up the product development and sales of pensions and other retirement products. He said that LV= is particularly disappointed by the lower projection reducing from 5% to 2%.

He says: “The adoption of this rate will mean that many investments show very low returns or even a loss, deterring many clients from saving, not just into pensions but through many other vehicles.”

If I didn't already believe that a great many people do lose money on pensions, that would be quite shocking. At 2%, after inflation and deceptively high pension costs, it could easily be argued you'd have been better off putting your pension contributions in a Cash ISA, or even spending it immediately.

Perks' statement is particularly astounding since, in my opinion, pension providers don't always seem to deduct anything like enough when they move on from the headline projections to show you your personalised projected real returns. These are supposed to deduct the cost of inflation and the hefty chunk they take for themselves in fees from your forecast, and give you a realistic idea of what your pot might grow to in pound terms.

As the regulator has found, pension providers also don't always reduce the three headline projections when it becomes clear they won't be met. The FSA is planning to strengthen regulation to enforce this better.

I expect that pension providers will be racking their brains between now and 2014 about how they can make your personalised projection look better to ameliorate the effect of the FSA's new lowered headline projection rates.

Reality at last

One campaigner who truly deserves both the title “pensions expert” and “consumer champion” is Ros Altmann, who is currently director-general of Saga, making her the lead spokesperson and a major influence on Saga policy as well as pensions in general.

She sums the changes up nicely: “Better late than never – the regulator finally forces some semblance of reality on pension forecasts.”

She takes the view that the projections will be “based on lower – and more realistic – investment return assumptions of 2%, 5% and 7%, which are likely to be closer to what markets will deliver.”

You can improve your own forecasts

I don't know if those projections for the next 10-15 years are more realistic as Altman says, but it's sensible to have conservative projections at all times, since the future is so uncertain – especially with your own specific pension pot.

Luckily, these headline projections are based on average returns not just for investing in shares, but for investing in government and corporate debt (called gilts and bonds respectively), and property as well. Since some of these assets don't usually do well in the long run, this pulls down the projection rates.

You could choose not to invest in most of those, however. Generally speaking, we should expect shares to perform best over the long run, which means that, on average, someone investing largely or wholly in shares will normally do better than someone investing in other assets.

After all, it's companies that produce almost all the economic growth over-and-above inflation (whereas governments seem to do their best to create inflation and destroy growth).

Unless you think there will be no companies left in 15 years' time, it generally makes sense to invest steadily and cheaply in a large number of them to have the best chance of partaking in this growth.

Regularly contributing money to cheap tracker funds across approximately eight countries, preferably staying mostly clear from the more corrupt or politically unstable countries, is a good way to take advantage of shares' growth without giving too much of your money to the financial industry, while massively limiting the chances of making after-inflation losses.

While you probably will end up looking back at the projections as complete nonsense, you should hopefully then find that you have got ahead of inflation and grown your pot of money.

More on retirement:

20 reasons pensions go wrong

How Zopa beats the stock market

Saving in a pension? You're as well off on benefits

Why women make better investors

Two simple ways to invest better in shares