Government still persists in encouraging people to save for their retirement through pension schemes. It is still pressing ahead with auto-enrolment for employees, albeit the timetable may be slipping. But with gilt yields through the floor and life expectancy continuing to improve, does the logic stack up?
Annuity rates fell over 9% between June ’09 and December ’12. Getting 4% on a Single Life policy is an achievement, getting it on joint lives a pipe dream. In another few years, the situation is likely to get worse rather than better. So what’s the underlying logic supporting the concept that saving into a pension fund makes sense?

Ignoring growth within the fund and the ravages of inflation, we have the following maths:

Assume the amount being saved is 100. The cost to a basic rate tax payer is 80, a higher rate payer, 60, and a top-rate payer, 50.

Under present legislation, 25 can be withdrawn as a tax-free lump sum. So the net cost of the remaining 75 in the fund is 55 to a basic rate tax payer, 35 to a higher rate payer, and just 25 to a top-rate payer.

Now assume that by the time the pension is taken, annuity rates have slipped to 3% on single lives, 2.5% on joint. That’s around 25% less than at present, which at present rate of loss (9% in 2.5 years) could be less than 10 years away.

The 75 left in the fund would produce, pre-tax, 1.875. On current basic rate tax, it’s worth just 1.5. So the basic rate tax payer might need to live over 36 years in retirement to recoup the net cost of his pension contributions. A higher rate tax payer wouldn’t need to live so long to reap a positive reward from his savings – 23 years if he was a basic rate payer in retirement, whilst for a top rate tax payer going down to basic rate, the reward kicks in after 16 years.

The figures are worse if basic rate rises. And they’ll be much worse still if the entitlement to draw a tax-free lump sum is removed.

But the anomaly here is that the wealthier you are, all other things being equal, the greater your life expectancy. So the people least likely to live long in retirement are those to whom the net cost of creating their pension pot is greatest. Expressing this the other way round, those least able to build their fund are those most likely not to get its value in their own lifetime.

Government will argue that auto-enrolment has built into it an employer contribution, so employees start not with 100, but perhaps 200. And government will also argue that with age-related personal allowances, you need a reasonable-size pension pot to generate an income that, combined with the OAP, would actually take you into a tax-paying situation. But the first argument doesn’t stand up to scrutiny, because the employer contribution will simply come off the total the employer’s prepared to pay for that employee, and the second depends on future governments not playing around with tax allowances – which government hasn’t?

Government promotes pension provision for one reason only – to ensure the taxpayer of tomorrow isn’t burdened with the cost of supporting those who haven’t made adequate provision for their old age. But when it transpires that those cajoled into saving via pensions would have been better off by far saving outside the pension regime, there’ll be hell to pay. Will the Financial Ombudsman be prepared to fine the UK Government for this particular miss-selling scandal? I doubt it.