The million dollar pension

By NEIL SIMPSON
Updated: 10:28 EST, 9 January 2005

AMERICA is firmly back in business after November's presidential election and workers in Washington DC are still heaving a big sigh of relief. If John Kerry had won, it would not have been only George W Bush leaving the capital on January 20. A change of president signals a massive upheaval in politically appointed personnel, with tens of thousands of civil servants forced to look for new jobs.

And losing a post in government means losing a rare benefit in American life - a secure, blue-chip pension scheme.

The most important US government employees enjoy benefits similar to those of Britain's fast-disappearing final salary schemes. These workers will be paid pensions based on their wages at retirement and the length of time they have been working.

But most other American workers have no such security. The country takes a sink-or-swim approach to retirement planning. Workers who take control of their own pensions can build up a valuable, tax-free fund and spend it on anything they choose. If they bury their heads in the sand they have no one to blame but themselves.

It is a situation that may sound worryingly familiar in Britain, where the crisis over pension funding seems to get worse by the day.

So what can workers - and the Government - learn about retirement planning from the US? Here are six key lessons from America.

1. Treat pension-savers as adults

THE tax advantages of British pensions have been steadily eroded since Gordon Brown became Chancellor in 1997.

But he guards the remaining ones so jealously that early withdrawals from pension funds are strictly prohibited.

In America, the system is far more flexible. Pension savers also receive tax breaks when they pay money into pensions, and on the growth their funds enjoy. But Americans can also withdraw money from most funds to pay for 'lifetime events' such as clearing mortgages, paying for college fees, or setting up businesses.

Colin Maloney, pensions development manager at Jupiter Asset Management in Britain, says: 'Surveys in America show that knowing you can withdraw money from your pension if you need to actually encourages people to contribute in the first place.

'Experience also suggests that by the time most people have built up some money in a pension fund, they are loath to touch it because they do not want to jeopardise their retirement.

'So the flexibility on withdrawals seems to mean that people have bigger, rather than smaller, funds on retirement.'

2. Give people responsibility

BRITAIN'S tax rules state that at least 75% of a pension fund must be used to buy an annuity by the age of 75. The idea is to ensure that pensioners have a guaranteed income for life and will not fall back on the state for help if they spend their fund on a Ferrari at 65, for example.

The theory is fine, but in practice annuity rates have now been so low, for so long, that buying one at any age now looks bad value. Pensions experts say that knowing this deters people from saving in the first place. In America, pension savers are trusted to make their own decisions about how to invest or spend their funds. They can buy an annuity, or they can dip into their funds whenever they need to.

Workers can also reinvest their funds elsewhere to provide the growth or income they need. They can, if they want, blow it all on that Ferrari, but evidence suggests that most people are more sensible than that.

Reform of the annuity rule in Britain, widely mooted for 2006, must be pushed through.

3. Force companies to do more

AMERICAN employers can claim valuable extra tax breaks for their businesses if more than a certain percentage of their employees contribute to their pension schemes.

Helen Zacharias, pensions consultant at GE Life, says this encourages a far higher take-up. 'In America, almost 90% of employers provide some kind of investment education,' she says.

'Many firms offer automatic enrolment into pension schemes and there are pilots of a new system called Save More Tomorrow, where employees agree that a proportion of future pay rises will go into the plan, avoiding any immediate cut in take-home pay.'

In Britain, low-cost stakeholder pensions were supposed to have a similar effect on the number of pension savers. But while firms are legally required to offer stakeholder pensions if they have no other scheme, there are no financial incentives for them to ensure anyone contributes. That means 75% of stakeholder schemes are ignored by British workers.

4. Don't underestimate the challenge

AMERICA has recently decided on the magic $1m (£530,000) figure for the size of fund that workers must have for a comfortable retirement.

Rebecca Peterson of investment adviser Hanley Peterson in Los Angeles says: 'For many people, that figure is unrealistic and even unnecessary. But it is concentrating a lot of minds on the challenge ahead and giving people a target they can aim for.'

In Britain, no catch-all figure is widely quoted. However, according to the actuarial department of independent adviser PSFM in London, a man of 65 would need a fund of at least £335,000 if he wanted to retire on the equivalent of two-thirds of the current national average wage of £24,000.

Higher earners who want to retire on the equivalent of two-thirds of their salary should ask their pension company how large a fund they would need. Keeping the frighteningly large figure in mind should encourage more of us to top up our pension contributions.

5. Don't rely on safety nets

BRITAIN is to launch the Pensions Protection Fund in April. This is our version of America's Pension Benefit Guarantee Corporation.

The schemes are designed to underpin failing company plans and ensure that workers who have paid into pensions all their lives cannot be left with next to nothing if the firm goes bust or closes the fund before they retire.

Unfortunately, America shows that setting up a strong system of guarantees on company pensions is not easy. The solvency of America's scheme is under threat as increasing numbers of companies walk away from their pension commitments - a $9.7bn (£5.3bn) surplus in 2000 has turned into a $5.4bn deficit today.

Experts say that having a safety net encourages firms to renege on their obligations-because workers will be protected. 'I would caution the UK to avoid the kind of outcome we find ourselves in,' says US Treasury Under-Secretary Peter Fisher, suggesting that without a huge funding boost, our fund will not be as effective as the Government hopes.

6. Don't mess with the state pensions

CONTRARY to popular belief, Americans qualify for a state pension - Social Security. Typical payments can add up to a healthy 45% of average earnings, far more than the UK equivalent.

Last week it was announced that there are plans to shake up the way these benefits are paid, which could cost newly retired Americans up to a third of their payouts. But should this happen, it will be the first change in 70 years.

Zacharias says: 'This relative stability makes it easier to work out how much people must save for a comfortable retirement.

'The more complicated the system, the harder it is to work out a pensions strategy, and the less likely any of us are to do it.'

'Saving is the priority'

Former secretary Mimi says: 'I worked for a private company in London and don't think I was ever told about its pension scheme, though it has one of the biggest in the country.

'In America, I've worked for small charitable organisations where you still get a lot of information about, and access to, a pension.'

Mimi, 38, who lives on the outskirts of Washington DC with husband Matt and their three-year-old twins Ella and Evan, says the American way is to take far more control over your own pension provision. 'You get the impression that if you don't start saving soon, you'll have a very tough future, so pension contributions take priority,' she says.

'Simple plan is the key'

'My working life has been varied, so my pension record is not great,' says Mark, 37. 'But while pensions aren't exactly the subject on everyone's lips back in America, we all know we have to look after our own futures, so there's pressure to start a fund as soon as possible.

'Fortunately, you can pay into your pension whenever you can afford it. When I get back to New York, I won't face penalties paying in extra contributions.

'Keeping pensions simple is the key to making them work for ordinary people.'