THE PARADOX OF PENSION FREEDOM

What does last week’s Pension Freedom Day mean for more than just the individual? The media coverage has been largely monochrome in its assessment of economic risk.

What about the big picture?

Opinion of the new policy aside, commentators seem to agree on one thing. ‘The risk’ is of retirees blowing their hard-earned savings in a spending spree and becoming dependent upon state welfare programs for maintenance. The imagined queue of new retirees outside Lamborghini showrooms and Luxury cruise operator offices makes for a compelling news story, after all.

Personal consumption

In a similar vein, a flood of articles warn of the risk of asset bubbles fuelled by a sudden inflow on pension money ‘freed up’ to chase speculative investments in property or equity. Yet is froth caused by loose cash and a surge in personal consumption the real danger? A witticism oft attributed to Churchill goes, “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.”

Macroeconomic outcomes depend critically upon human behaviour at both the individual and group level, which can be notoriously difficult to predict.

Underestimating longevity

Will diligent savers, who have toiled through their working lives to put together a pension pot, undergo a personality shift post-retirement and hastily consume their savings with little thought to future sustenance?

Possibly.

There are, in fact, actuarial studies which show that retirees tend to underestimate their own longevity by 5-8 years. Is this the only or even the most likely outcome?

Probably not.

The paradox of freedom, especially in the context of pension money, is that the newly granted freedom to spend may actually constrain the flow of money in the economy.

 

‘A preference for liquidity’

Some pensioners, put off by the current low interest rates, may take advantage of the new rules to avoid locking into annuities. They could draw-down significant amounts of their pension pots, but – and here’s the rub – don’t spend it!

People often demonstrate a preference for liquidity over real assets – a phenomenon clearly seen in periods of vulnerability like economic downturns. A large part of the present investments in annuities make it back to the market in the form of bonds and loans to corporates. If this pool of money is depleted and instead held as a ‘rainy day buffer’ by retirees either as cash or in demand accounts, the market for loanable funds would shrink. Consequently, this would put downward pressure on the economy. Ultimately, we would return to that economic Cassandra, Lord Keynes and his related Paradox of Thrift. If each individual attempts to save more, total savings might fall through a reduction in demand and output.

April 6 marks the beginning of a fascinating social experiment. Maybe the question which requires more attention is not if this new found freedom will make retirees more reckless, but if it will make them too thrifty?

 

Author: Neha Bhargava

Prior to joining Redington in 2009, Neha worked at Merrill Lynch, London with the Rates Structuring group and at Merrill Lynch, Hong Kong with the Securitization group. She holds an MBA from the Indian Institute of Management, Ahmedabad (IIMA) and a BA (Hons) in Mathematics from St. Stephens College, Delhi University. Neha currently works in the investment consulting team on a number of trustee and sponsor-side appointments spanning the breadth of Redington’s client base.