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How will inflation affect your pension?

Just 16% of adults understand how the government's 'inflation switch' is affecting their retirement savings.

 

by Michelle McGagh on Aug 16, 2012 at 09:50

How will inflation affect your pension?

Pension savers are still in the dark about the impact the ‘inflation switch’ brought in by the government two years ago will have, despite the possibility that it could wipe 25% off their retirement income.

Research by human resources business Aon Hewitt shows Brits do not understand what effect the switch from the retail price index (RPI) to the consumer price index (CPI) has had.

Switch from RPI to CPI

Two years ago, the government announced plans to move the indexation of pensions from RPI to CPI. It did this because CPI rises a lot slower than RPI, as the latter includes housing costs, so it means the state pension will rise more slowly, as will public sector pensions, costing the government less money.

When it comes to private pensions, the amount they pay out could also increase more slowly as many are tied to inflation, and would have adopted CPI instead of RPI.

However, a survey of 2,000 people over the age of 18 showed that just 16% of people felt adequately informed about the relationship between inflation and their pension. Although this is an increase from 10% in 2010, it is still a small percentage of the population. Just 26% of respondents knew the difference between CPI and RPI, a 1% decrease from 2010.

Many were confused about the impact the inflation switch would have on their pension, only 31% correctly said the move would reduce their income in retirement.

1% annual fall = 25% less pension

A total of 3% said their income would be reduced by up to 1% a year, which is what Aon Hewitt expects to happen. It warned that the 1% fall could accumulate and wipe up to a quarter off of savers’ retirement income.

Lynda Whitney, partner at Aon Hewitt, said: ‘Two years after the chancellor announced the switch from PRI to CPI as the inflation measure for public sector pensions and the statutory revaluations for private sector schemes, the public remains in the dark over the difference between the two, and whether their pension is impacted.

‘Furthermore, the majority of people are unaware of the potentially significant effect that changes in inflation and the move to CPI could have on their income in retirement. 1% a year may not sound much but over both the period from leaving service to retirement and the retirement period this could lead to a reduction of 25% of their retirement benefit.’

Do you understand inflation?

As part of its survey Aon Hewitt asked people to calculate the following sum to see if they understood inflation:

‘Calculate the decreased buying power of £100 after 10 years of CPI at 2%, the Bank of England’s target rate’. The answer: £20.

Whitney said: ‘Most people might need a calculator to reach the precise answer, but I would hope they could think that if 2% of £100 is £2, then £2 a year for 10 years is £20.’

However, just 34% of people were in the correct range for the answer of £10 to £25.

101 comments so far. Why not have your say?

Jeremy Bosk

Aug 16, 2012 at 10:39

All they need to know is that pensions are a rip off.

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roger cole

Aug 16, 2012 at 12:24

Closely followed by civil 'servants'.

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Geoff James2

Aug 16, 2012 at 12:28

@Jeremy - that is harsh and adds nothing to the discussion.

Standard pensions may not be appropriate for people that have the asssets and viable financial plans in place for their retirement.

The sad fact is that most people don't have the plans and seem unable/unwilling to amass the asssets. Pensions are the best option - they provide a plan and place the assets as unaccessible, until it is time to use them for the purpose of funding lifestyle when working is not an option.

Unless you put forward an alternative you should not knock what we have. It encourages people to take the do-nothing route and that just leads to poverty and/or dependence on the state. Or do you advocate that?

Regards

Geoff

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Geoffrey Nicholls

Aug 16, 2012 at 12:37

We nees a new index, a Pensioners Index based on the spending patterns of pensioners. On average pensioners spend a larger proportion of their income on such things as food and heating and less on clothes luxury goods etc.

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Sinic

Aug 16, 2012 at 12:47

Well said Geoff James 2. That said Public sector pensions are a rip-off .... for the private sector taxpayer!

How can a retirement savings structure which permits the saver to have the option to select his/her own investments from a massive market choice including funds, trusts, individual stocks, gilts, deposits and bonds at low cost; to receive income tax relief at their highest rate of income tax on their retirement savings, to have the growth on those savings free of income and capital taxes, to receive 25% of the combined savings and growth tax free, and to then have the choice of a retirement payment structure of either a fixed or increasing income for life or to continue to draw an income from invested funds to age 75 be called a rip-off for the recipient.

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chazza

Aug 16, 2012 at 12:50

I've paid into a final salary pension scheme for most of my working life, and always advised younger colleagues to do so. But I now find that, because of the change in indexation, it will not deliver as expected, so I have either to adjust my expectations of retirement income downward, or work several years longer than planned. Fortunately, I did not make additional voluntary contributions, else I would feel quite severely ripped off. The final salary scheme has now closed to new entrants, and I no longer feel able to recommend making pension contributions to younger colleagues who are increasingly burdened with debt from student days. I know this is storing up trouble, but when government can so easily change the pension rules, I don't see how anyone can have confidence that making contributions to any pension scheme is anything more than a gamble. So I now think it is better to spend and enjoy life while young and worry about retirement much later....

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ND

Aug 16, 2012 at 12:51

Re ‘Calculate the decreased buying power of £100 after 10 years of CPI at 2%, the Bank of England’s target rate’. The answer: £20."

The answer is NOT £20!!! Inflation is cumulative and compounds, and the end effective buying power is the reciprocal of it.

10 years of CPI at 2% will result in inflation of 21.9% across the decade. A can of beans costing £1 now will cost £1.219 then, and where £100 will buy 100 cans of beans today it will only buy 82.03 cans of beans then.

In other words the buying power of £100 will drop to £82.03 (in today's £) across the decade, so the answer is £17.97.

How ironic that those asking the question of people "to see if they understood inflation" have demonstrated that they don't understand it themselves!

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Rose G

Aug 16, 2012 at 12:55

Why should I pay into a pension for close on 30 years only to be told just a few years to collect my pension that the goal posts have been moved and I will receive less but need to pay more than was predicted right up to now?

Governments want us to save into a pension, then this is something that needs to be guaranteed, not up for change because they fcuked up the economy by letting their buddies bring our economy to near bankruptcy - none of the cheating bankers have lost their bonuses and pension packages, have they - how come they are not affected, yet it was mainly their ideas that were put into place without appropriate governance or regulation?

It is a fcuked up world we live in and we can blame our politicians for that!

Anyone wonder why the UK requires so much of security? because the chickens are coming home to roost - we have been very quick to invade other countries, devastating their local population and their economy for eternity, and hence we need extra security because of the enemies our foreign policies create. The British public should have nothing to fear from other nationals, they live in fear because of what their government has been doing abroad, hence, men with guns at the airport, thousands of soldiers drafted in to guard the Olympics.

It is astonishing when we travel to other countries where they have minumum of staff at airports and as for security, it is non existent.

If we continue in the vein as if we are a superpower, when our economics demonstrate that we are not, no wonder then that people who have lost their whole life and way of life as a result of our government's action, there are many who wish us harm.

As for pensions industry, the only people who benefit is the pension fund managers, those selling dodgy products but have the green light to go ahead, until further down the line when people have lost all their investment, some regulatory or monitoring agency announces the mis selling scandal - only after many have been robbed of their hard earned money, several years after the findings, do they announce this - when to all intents and purposes, the perpetrators have retired or retired their money to offshore accounts.

The system has been set up with the intent to rob us of our money, while earning scamsters to earn their money, with no come backs.

I once believe that no one entered into politics to pull the wool over the electorates eyes, but it is now my belief that this is their sole aim, that and to gain some kind of reputation for themselves which will last into eternity -

Here is my perception of the following:

T Blair - war criminal

G Brown - dumbass pretending to know something about finance

Cameron - chamelion like but not as innocent

Clegg - most vile character this side of the Tropic of Cancer

Bankers - more like wankers!

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Paul 2

Aug 16, 2012 at 13:03

The sad fact is that many/most members of DC schemes will find this change in indexation irrelevant. This is because the only way they can achieve anything approaching a half-decent retirement income is through buying a non-indexed annuity.

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Serge Quimper

Aug 16, 2012 at 13:45

I thought that it was just me, but ND has confirmed it!

I am forced to conclude that financial "advisors" can't tell an arithmetic progression from a geometric progression :-( The standard of education these days!!

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Jonathan

Aug 16, 2012 at 13:59

‘Calculate the decreased buying power of £100 after 10 years of CPI at 2%, the Bank of England’s target rate’. The answer: £20.

Well approximately £20, the actual answer is £17.97. You would need £121.90 to have the same spending power after 10 years: (1.02 ^ 10) * £100 = £121.90.

So £100 would have the spending power of £100 \ 1.219 which is £82.03. So the correct answer is just under £18.

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Jonathan

Aug 16, 2012 at 13:59

Sorry ND I hadn't seen your reply.

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ND

Aug 16, 2012 at 14:15

Indeed, Serge, but it's worse than not being able to tell an arithmetic progression from a geometric one, it's a basic failure to think , in particular highlighted by:

"I would hope they could think that if 2% of £100 is £2, then £2 a year for 10 years is £20."

So according to Ms Whitney if inflation were 100% (prices doubling every year), then as 100% of £100 is £100, your money after one year (rather than being able to buy half of what it could the year before) would be totally worthless, and after ten years your original £100's buying power would have decreased by £1000 making it worth MINUS £900!! Brilliant, eh?!

I also liked:

"just 34% of people were in the correct range for the answer of £10 to £25."

The correct RANGE, eh?! Since when did such mathematical calculations have a "correct range" of answers -- especially one so wide?! According to these people a "correct" answer for 1 + 1 would be anything from 1 to 3!

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Dennis .

Aug 16, 2012 at 14:40

What sort of idiot becomes a financial journalist? Well we just found out didn't we? I wonder if Michelle McGagh keeps her job after this?

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Tony Peterson

Aug 16, 2012 at 15:04

A breathtakingly stupid article. Jonathan and ND have pointed out the mathematical idiocies in it (why does innumeracy almost always go with the patronising arrogance that the author is much smarter than most people).

The assumption that the CPI will always increase less than the RPI is also bunkum. If housing costs were to revert to their historic mean, the CPI would grow faster. No doubt when it does the government of the day will start rerating pensions by the RPI.

I think Michelle should be made to take an O level exam. Oh, I forgot, exponential sequences have dropped out of O level.

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DavidHd

Aug 16, 2012 at 15:19

Tony I could not agree more. The trouble is with O level grade inflation she would probably get an A* even if she gave answers within her own range!

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Jeremy Bosk

Aug 16, 2012 at 15:23

Tony Peterson

The O-level went the way of the dodo decades ago :-)

Geoff James2

Aug 16, 2012 at 12:28

Equity ISAs are the current best answer to rip off pensions. The legal uncertainty on pensions is even more off-putting than the extortionate charges.

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ND

Aug 16, 2012 at 15:27

I think the last few comments are a bit unfair to Michelle McGagh, as she was just reporting what Aon Hewitt had done and Lynda Whitney (partner at Aon Hewitt) had said about it. Ok, maybe Michelle should have challenged them on it, but it's them that are the idiots, not her.

You don't shoot Jon Snow when a politician he's interviewing says something silly....(we'd have no journalists left! :-)

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Dennis .

Aug 16, 2012 at 15:38

It is the duty of a journalist to challenge your sources and check the basics of what you are being told. I didn't even need to do the calculations to see that something was wrong and that the article was rubbish. We are talking about a financial journalist here and not some generalist off the Daily Mail.

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ND

Aug 16, 2012 at 15:44

It is also the duty of a journalist to report what people are saying, even if it's rubbish.

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Jeremy Bosk

Aug 16, 2012 at 15:53

ND

The reporters on this site have to develop thick skins because a very high proportion of respondents want to shoot the messenger. Which is worrying for the respondents' investment returns if they read RNS statements and company reports with the same (lack of) attention to detail.

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Brian Richards

Aug 16, 2012 at 15:56

Michelle you should check your information before you send it out, no maths 'o' level then?

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Jonathan

Aug 16, 2012 at 16:04

A great thing about this site is that you can have your say pretty much uncensored. So let's not make too much fuss or abuse about the odd minor mistake. For small percentage rises over a few years it is a good approximation to just work out the percentage for one year and multiply it by the number of years. Even a mathematician will tell you that Sin(x) is approximately x for small x.

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Jeremy Bosk

Aug 16, 2012 at 16:18

Dennis

This site depends for its income on advertising. A lot of the interviews are basically product placements. That the advertisers are stupid enough to make statements which can be ridiculed absolves the journalists from any need to upset their meal ticket. Read the same journalists when they are commenting on politicians or on companies that do not advertise here and you will see the difference.

Meanwhile we get some really excellent resources and do not have to pay for them. This is one of the lessons taught on those unfairly maligned media studies courses.

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nickle

Aug 16, 2012 at 16:22

If a median worker (26K a year) had put their NI into the FTSE over the last 40 years they would have a pension of 19K a year. Instead the government gives them 5K.

Now its broken the link with RPI. That's more money off because the 19K is RPI linked.

The 19K is fully joint life, unlike the state pension

The 19K a year is at 65. Government has upped the state pension to 67.

The reason is no compound interest, plus diverting the money elsewhere. The latter having the same effect as a massive tax on state pension contributions.

Now since they have no assets to back up the massive debts even for the small 5K a year pension, its going to become even more of a rip off.

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nickle

Aug 16, 2012 at 16:24

It is also the duty of a journalist to report what people are saying, even if it's rubbish.

===========

So they report the government figures for government debts, at 1 trillion. They just report it because its rubbish. OK, so far fair enough. However they should report the fact that politicians are talking rubbish. They don't.

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Jeremy Bosk

Aug 16, 2012 at 16:41

nickle

I find it interesting that you and I can visit the same site and come to opposite conclusions on the competence and integrity of the journalists.

If you really think they are so bad, why do you bother visiting?

Differences of opinion are what make a market be it in shares, politics or soy bean futures. My shares are up five per cent so far this week. Just saying :-)

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roger cole

Aug 16, 2012 at 16:41

Regardless of whether RPI or CPI is used, a bigger crime is how the financial industry is allowed to levy charges that take so much of the value out of the final pension received. RPI or CPI is just small beer, although you can bet the objective is not to increase the amount paid to the pensioner! I believe in Holland they do these things better.

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Jonathan

Aug 16, 2012 at 16:44

nickle

NI does not just go on pensions. Originally it was also meant to pay for the NHS too. It's now just another form of tax.

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ALANR

Aug 16, 2012 at 17:18

There are two winners and one idiot when you invest in a private pension. The two winners are the provider and the government. The last place any young person should put their money is in a private pension. I speak from experience.

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Rodney Clarke

Aug 16, 2012 at 17:56

2% pa takes 36 years to double initial sum. In the last 36 years RPI as risen 647% and CPI 418%. 3% pa takes 24 years to double initial sum. In last 24 years RPI as risen 232% and CPI 198%.

God help the pensioners.

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nickle

Aug 16, 2012 at 18:13

.I find it interesting that you and I can visit the same site and come to opposite conclusions on the competence and integrity of the journalists.

If you really think they are so bad, why do you bother visiting?

==============

So how many times to you hear a journalist question the accuracy of government debt figures?

Note that the government pushes the number as a 'debt figure' whereas the number is in fact the 'borrowing figure'.

The true debt is much higher.

Now the critical issue about this is when you look at the debt figure and compare it to tax revenues, its obvious that they can't pay.

So then you look at what they can't pay, and its the state pension, state second pension, civil service pension. The big debts are pensions.

So if they can't pay, what are the people who are reliant on those payments going to do? They can't go on benefits, because if they can't pay the pensions they can't pay the benefits.

You need to work out the consequences.

So that's the issue with journalism. They don't question, they just repeat what has been told to them.

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nickle

Aug 16, 2012 at 18:15

NI does not just go on pensions. Originally it was also meant to pay for the NHS too. It's now just another form of tax.

=============

No it wasn't. It is only recently that 1% of NI has gone on the NHS.

The rest pays for

1. State pension

2. JSA

3. berievement benefit.

In part I agree. However, the effect of not having a fund is effectively a tax on people's pensions.

Since they pay out 5K, when a median worker would have got 19K from the FTSE, that's effectively a 75% tax on the state pension.

Kind of makes private pensions look gold plated.

The government has made people poor.

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JohnnyM

Aug 16, 2012 at 18:23

I objected to this change via my MP before it happened, and was given a load of bullshit from Mr Webb's Dept of Pensions. My Pension scheme has unilaterally changed from RPI to CPI and this is going to wipe out 25% of my income over the next 10-15 years unless this is reversed, or if the CPI definition is altered to be more realistic. Even Mervyn King agrees CPI is rubbish as a real measure of inflation Short term cost cutting to solve a deficit is one thing, but wiping out the value of 60 Million peoples' pensions is, in my opinion, tantamount to state fraud and theft..

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nickle

Aug 16, 2012 at 18:30

Regardless of whether RPI or CPI is used, a bigger crime is how the financial industry is allowed to levy charges that take so much of the value out of the final pension received. RPI or CPI is just small beer,

================

1. Use a SIPP. However, even with a SIPP there are charges you can't avoid.

Regulation costs.

Bid offer spreads

Stamp duty.

All costs you can't avoid, and all down to the government.

What should happen with pensions is this.

1. You can move between providers at cost.

2. Caps on any charges.

3. Referenda is required if the government wants to tax pensions.

4. Pension saving to be compulsory.

The real risk, is that the government takes the Hungarian option and confiscates all pension assets for the 'common good'.

After all with debts of 7,000 bn on taxes of 570 bn, they haven't got enough money. So the temptation to steal to pay their own pensions is high.

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nickle

Aug 16, 2012 at 18:41

but wiping out the value of 60 Million peoples' pensions is, in my opinion, tantamount to state fraud and theft..

============

And the cause its that they can't pay because they have spent all the money and not invested it.

The payments are back end loaded. They paid out small amounts initially compared to the cash they took. That is just the same as saying that in the future its going to flip the other way. More payouts compared to money in. And no compound interest.

Now the debts are falling due they can't pay. Hence the default.

The reason its happened is that they have been running fraudulent books, hidding the pensions debts off the accounts.

So with journalists who won't question or investigate, they got away with it.

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Jeremy Bosk

Aug 16, 2012 at 19:10

nickle

There are many journalists who ask the hard questions of government and point out the flaws in their calculations. Not just on this site but the FT, Investors Chronicle, Telegraph, Guardian and on a whole host of financial blogs.

Making pensions compulsory just reduces the low paid to absolute beggary and starvation. Given a decent income and some certainty that their savings will not be lost during unemployment and sickness or due to retrospective rule changes, the vast majority would save without coercion.

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M Artian

Aug 16, 2012 at 19:38

Dear ND.

Here is the calculation ...

10 years of 'negative' compound interest rate of 2% makes a sum of £100 worth just

£100 * 0.98**10 = £ 81.7

(I have had to use '**' to denote a power, so for example 2**3 = 8).

Thus, £100 will have lost £100 - 82 = £18.

I don't see an 'inverse' in sight. It's a pity that none of you you can do sums, but hey-ho, that's why we are in the mess we are in.

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Jonathan

Aug 16, 2012 at 19:41

nickle,

NI now has nothing more to do with pensions than any other tax apart from needing 30 years contributions to get a full state pension, it's just another tax and the contributions obtained may be more or less than pension payouts, it doesn't matter.

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Jonathan

Aug 16, 2012 at 19:41

nickle,

NI now has nothing more to do with pensions than any other tax apart from needing 30 years contributions to get a full state pension, it's just another tax and the contributions obtained may be more or less than pension payouts, it doesn't matter.

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ND

Aug 16, 2012 at 20:17

M Artian

No, that's not correct. The correct answer is £82.03, not £81.70, and the correct calculations are as I specified at 12:51 and Jonathan specified at 13:59.

You have made the basic error of assuming that 2% up is the same as 2% down (or -2%). It isn't, and the easy way to see that it isn't is the same as I used in my critisism of Ms Whitney's nonsense arithmetic at 14:15 -- use a big number, like 100%.

!00% inflation would mean that after a year your buying power would be halved (i.e. a negative rate of 50%) not totally gone to zero, as your formula would have. £100 * 0**n = £0 for any n.

In general before telling everyone, "none of you you can do sums", it's a good idea to make sure you can do them yourself :-)

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Tony Peterson

Aug 16, 2012 at 20:34

Well, ND, that's landed a killer punch on the little green man.

Nice to see some real mathematics kicking in in response to the inept parody of numeracy the article offered.

I especially liked Jonathan's reminder that approximations can be valuable. Yes indeed sin(x) is close to x (in radians) for a very small x. But going the next step and subtracting x cubed over three factorial is much closer for a much wider range. However, to get it exact you have to go on forever.

And that is the answer to the pensions problem. Go on forever and you'll get your contributions back one day.

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Paul 2

Aug 16, 2012 at 20:39

Another answer offered by politicians to the pensions funding problem is economic growth. They use the word growth as a euphemism for growth in the working population. In other words, the solution offered is immigration into the UK of people who will work to keep us well housed and fed (and in particular keep the politicians thus) when we get old.

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nickle

Aug 16, 2012 at 21:24

Making pensions compulsory just reduces the low paid to absolute beggary and starvation. Given a decent income and some certainty that their savings will not be lost during unemployment and sickness or due to retrospective rule changes, the vast majority would save without coercion.

================

Completely the opposite.

You can work this out quite easily.

If we take that median worker. It's 26K per annum at the moment. We can use historical average wages to work out what a median worker would have earned in the past.

Now we take their NI contributions, and we back test by investing the NI into the FTSE 100. At the end of the year, you might have made or lost money, and you would get a little in the way of dividends. Then for the next year, we add the contributions, we get some dividends, and we make or lose money on the capital. At the end we have a lump sum. With that we go out and buy the most expensive annuity going.

65 years old, joint life, RPI linked.

End result 19K a year.

Compared to the government offering of 5K a year.

So if NI has to be saved in a fund, that median worker, 26K, would have 19K a year, inflation linked, joint life.

If you also test it against someone on minimum wage, they would still be better off.

The problem is the effective 75% tax on the state pension where the money is siphoned off for other things and other people, and that there is no compound interest.

For Paul 2.

Migration won't work. The government spends 11K a year per person. You have to be on over 40K a year, with no dependents to make a positive contribution to the government spending. How many migrants do that?

That's what the test should be. Pay more than 11K in tax, per migrant, and you can stay. Pay less, thank you, but you have leave.

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nickle

Aug 16, 2012 at 21:25

Another answer offered by politicians to the pensions funding problem is economic growth.

===========

The other part of growth. Growth has to be higher than the increase in the debts.

Since the true debt went up by 500 bn last year, on tax revenues of 570 bn, its not going to work.

150 bn on borrowing, 350 bn increase in the inflation linked pensions.

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roger cole

Aug 16, 2012 at 21:58

Does anyone know a way to turn off emails without posting a comment?!

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Jonathan

Aug 16, 2012 at 22:24

roger cole,

If you haven't unsubscribed from this already. Try clicking the "Don't send alerts for this discussion" link on the discussion emails?

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roger cole

Aug 16, 2012 at 23:52

Thanks Jonathan but on the emails i receive that link is not clickable ...

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Jeremy Bosk

Aug 17, 2012 at 01:28

Interestingly, none of the links except the thread title work on my emails either. I use Yahoo!. Maybe the emails are only tested on Outlook and Safari? Which would be silly because outside the corporate setting most people use web email.

On the growth issue there is also increased productivity from better education and improved technology. But the real thing that will save the politicians bacon - in purely nominal terms - is inflation: which will eventually make all our problems go away, along with the real value of our savings.

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nickle

Aug 17, 2012 at 08:53

the growth issue there is also increased productivity from better education and improved technology. But the real thing that will save the politicians bacon - in purely nominal terms - is inflation: which will eventually make all our problems go away, along with the real value of our savings.

============

The opposite is the case.

Look at the debts.

Gilts. 1.1 trillion. 0.8 trillion fixed rate - where inflation works The rest is indexed linked, where it doesn't.

Losses on guarantees. For some, such as the banking losses (small percentage, most of the losses are Gordon's share trading), inflation will work. Remember that the share trading is on credit, with borrowed money. Inflation means that interest rates go up. Doesn't work as well as you might think.

Now for the big debts. Civil service, state, state second pension, PFI, nuclear decommissioning, guarantees for pensions like the Post Office, BT, are all inflation linked. That's 6 trillion linked to inflation. You can't inflate those away, you have to default.

Now if you use inflation there is a side effect. It's depriving pensioners of incomes. That means more on benefits, and you spending goes up. Benefits or debt payments, its money going out.

So on balance inflation makes it worse not better.

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roger cole

Aug 17, 2012 at 09:12

Meanwhile, as inflation bobbles along under 3%, what about the BoE printing money (Qualitative Easing)? I can't help fantasising how it would be if this were given out to pensioners to spend instead of being given to the banks.

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nickle

Aug 17, 2012 at 09:53

Except the banks 'haven't got it'

The money went to the banks, who were then forced to lend it back to the government, who since spent it.

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Jeremy Bosk

Aug 17, 2012 at 10:16

The government is gradually weakening the inflation link by changing from RPI to CPI and will switch back whenever convenient. It will also keep raising the pension age and chipping away at benefits of all kinds. It is forcing a cut in living standards. You might say that our debts are forcing the cuts but that is a chicken and the egg situation. Productive investment would float all boats.

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Jonathan

Aug 17, 2012 at 10:16

nickle,

I thought the government (BoE) created money and then bought back government debt at a high price from the private banks. So the banks end up with the money and the commission, the government ends up with free money to spend and the general public end up with monetary inflation. Not a very Keynesian view, I know, but the Bank of England's inflation estimates against actuality show that they are missing an monetary inflation as a parameter in their calculations.

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nickle

Aug 17, 2012 at 10:29

Pretty much Jonathan.

Now work out what their exit strategy is for QE. Suddenly the government has to find all the QE money when the repos come to an end. Where's it going to get the cash from?

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nickle

Aug 17, 2012 at 10:33

Jeremy,

Take that average (well median) worker on 26K a year. They have been ripped off as it stands because if their NI had gone into the FTSE, they would have got 19K a year. Instead they get 5K. So they are out by 14K a year anyway.

Now raise the retirement age by 2 years. That's 38K lost. On top they have to pay NI for another two years. Factor in all the NI, and that is 9K. They are down 47K.

Now the break from RPI to CPI is 25%. Since the 19K a year needs a fund of 600K (what they would have got from the FTSE investment), that break is effectively taking 150K from them,

Now 26K a year can hardly be considered rich, so the sums involved when you look at the theft are massive.

It's a massive default by the government and the terrifying thing is that this is just the start. There is far worse still to come. They can't even pay the 5K linked to CPI.

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ND

Aug 17, 2012 at 11:19

Jonathan/Nickle

No, that's not correct. The BoE is not the government, and the government (HM Treasury) gets nothing from QE.

The BoE has, indeed, created money and used it to buy govt debt (gilts), but it still holds that debt and the government (HMT) is paying the BoE the interest on it, just as it does for all holders of gilts. The debt has not been cancelled/nullified/suspended and the govt has received no "free money" (no money at all in fact) from the operation.

The BoE did not pay the banks "a high price" for the debt, it paid the market price. However, the act of buying up large amounts of gilts has raised their price (supply & demand) and thereby lowered their yields, thus lowering long term interest rates, which is one of the intended effects of QE (as lower interest rates should stimulate the economy).

The other intended effect of QE is that the banks lend more, as it increases their excess reserves, and in regards to monetary inflation, this will only come about if the banks do, in fact, increase lending. However, as we all know, the banks haven't been lending out, preferring to use the excess reserves to rebuild/increase their balance sheets instead, so *so far* there has been little/no QE caused inflation.

Eventually the BoE will (should!) undertake quantitative tightening to reverse the process, i.e. sell off the govt debt it holds and destroy the money it receives from selling them (the exact reverse of QE). QT should result in deflationary effects that, if done "perfectly" (ha!) will cancel out any inflationary effects of QE. We'll see :-)

Anyway, as I say, the BoE is not the government and the government gets nothing from QE (and has no involvement in unwinding it either). It's all between the BoE, the banks, and the economy.

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Jonathan

Aug 17, 2012 at 11:34

nickle,

I can't really see an exit from QE, well they won't reverse QE by selling back the government bonds to the market but when the economy recovers and the deficit is low enough that the government can afford to pay more interest on their new debt I can see them reverting to using interest rates to control the economy. QE is addictive for the government, it allows them to borrow as much money as they like at low interest rates so both the government and Bank of England are blind to QE being a cause of inflation.

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Jeremy Bosk

Aug 17, 2012 at 11:39

nickle

I agree that workers have been and are being ripped off. I question the relevance of arguments based on National Insurance which, while theoretically paying for both pensions and the NHS, has long been put into the general pool of government revenue. It is not hypothecated. I would oppose hypothecation anyway as imposing too much rigidity and probably unnecessary expense.

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Jonathan

Aug 17, 2012 at 11:44

ND,

The Government has made it look like the BoE is not just another arm of the government. They have also made it against the law for the BoE to buy debt directly from the government. But this is just window dressing,

The BoE just buys the government debt from the open market, little difference from buying directly from the government. And the appearance of independence of the BoE makes it seem like a totally different set up from countries like Zimbabwe who printed money to directly finance government spend. But what is the difference? You have one arm of the government (the BoE) buying government debt from the private market and ignoring their interest rate targets. The end result is the same.

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nickle

Aug 17, 2012 at 12:05

I question the relevance of arguments based on National Insurance which, while theoretically paying for both pensions and the NHS, has long been put into the general pool of government revenue

===========

The relevance is this. Read government websites about what it says NI entitles you to. That is what NI pays for.

Now what is clear is that NI is being leaked into the general pot, as you say. There is no difference between this and just saying, we are going to tax your state pension at 75% (and you still get to pay income tax on the 25%).

That's the point. The state pension is awful value for money. Dire. It's the cause of pensioner poverty in the UK.

When even a min wage earner would have been better off putting their NI into a FTSE based fund, its just awful.

The next part, by making it clear that there is a 75% rip off, it puts the blame where it lies.

Political fraudsters.

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nickle

Aug 17, 2012 at 12:08

I can't really see an exit from QE

==========

My take too. However, no one is asking government how they are going to get out of the mess they have made.

If QE is to inflate the economy, the undoing of QE does damage. If you take the Keynsian voodoo that you can cure a recession caused by too much borrowing and spending by applying more borrow and spend.

My take, they are just going to cancel the debts they own, adding to the money supply permenantly. ie. Zimbabwe.

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Paul 2

Aug 17, 2012 at 12:31

Adding to ND's good comments, the Bof E has been both a buyer and seller of gilts, not necessarily to the same people.

The QE programme has been run separately to the gilt sales program and has targeted 'cheap' gilts, cheap in the sense that their prices lay outside the yield curve. Thus, amongst other things, it has had the effect of providing smoothing and liquidity to the gilt market.

To provide some (rather old) figures, an investment bank last November predicted in its research that 'On a calendar year basis we expect £185bn of gilt supply in 2012 to be fully offset by £43bn of redemptions and £150bn of QE gilt purchases'.

If QT is introduced for the purpose of cooling down a heating-up economy then this would presumably be a good thing. However, there is no substitute for good government by the Government.

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nickle

Aug 17, 2012 at 12:46

If QT is introduced for the purpose of cooling down a heating-up economy then this would presumably be a good thing. However, there is no substitute for good government by the Government.

==========

QE (not QT - I presume a typo) is designed to inflate an economy by pumping in more money.

However, at the same time you have increased capital requirements for banks. (Vince Cable for you), which means less lending. The amount of reduction is gearing * increase in capital. Assume gearing of 10 fold.

Similarly, fining banks. The fine comes out of capital. So the result is another 10 fold decrease in lending.

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Paul 2

Aug 17, 2012 at 13:00

No, QT wasn't a typo. The abbreviation QT was used above by ND and I took it to mean Quantitative Tightening.

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roger cole

Aug 17, 2012 at 13:03

Good reading for a dummy this thread. If not so much the original article ...

Nickle. I think it wasn't a typo, Paul was picking up on ND's term for what to apply when QE has succeeded in heating up the economy (if). His term is QT for the opposite, qualitative tightening, to cool down the economy. It would need to be applied carefully, gently on the brakes ...

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ND

Aug 17, 2012 at 13:05

Jonathan,

The BoE buys (and sells) govt debt on the open market as part of its normal day-to-day operations to control interest rates, base money and inflation. This is (unsurprisingly :-) called "Open Market Operation" if you want to look it up.

What's different about QE from normal OMO is that (a) the BoE creates new money for the purchases and (b) the sheer scale of it.

The difference between the BoE buying debt directly from the government and buying it on the market (or from banks) is that in the latter case the BoE is buying *already existing* debt, not new debt that the govt is issuing. QE is separate from govt borrowing, it's perfectly possible to run a QE program without the govt issuing any new debt at all.

It is also different from printing money to directly finance government spending and comparisons with Zimbabwe really are just quite inappropriate, but you don't have to believe me, you can ask the markets. If the markets thought that QE was even a fraction of the way towards what is being said here then the pound would be going through the floor and long term interest rates would be sky rocketing. However, instead the pound has been pretty stable for the last 3 years or so and interest rates continue to fall.

I share your cynicism about the govt (well, govts in general actually :-), but the predictions of doom and gloom (let alone Zimbabwean style apocalypse) just aren't shared by the markets.

Of course, the markets could be wrong ... :-)

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ND

Aug 17, 2012 at 13:13

Just to be honest and not claim any unwarranted credit :-)

QT & Quantitative Tightening are not "my" terms, as a quick google will show...

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nickle

Aug 17, 2012 at 13:26

QT / QE - please accept my apologies for reading it the wrong way.

I agree. They won't want QT when they reverse QE. My guess is they just write off the debts they have bought. Same as printing money and spending it.

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nickle

Aug 17, 2012 at 13:29

ut the predictions of doom and gloom (let alone Zimbabwean style apocalypse) just aren't shared by the markets.

========

The markets just care about getting their money back. The government owes far more than Gilts. For example pensions that people have paid for in hard cash, or contracts such as civil servants.

AAA doesn't mean anything when it comes to paying those, since AAA just relates to the odds of Gilts being paid.

Total up the past, accrued rights (not future pension accruals), and the other debts and they come to 7,000 bn. On tax revenues of 570 bn. 12-13 times geared, assuming all the cash goes on debts, non on services.

That's why the situation is as bad as Zimbabwes. Remember printing = inflation. Most of the debts are inflation linked.

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ND

Aug 17, 2012 at 13:47

"They won't want QT when they reverse QE"

QT *is* the reverse of QE.

"The markets just care about getting their money back"

The markets care about their *real* returns. If the markets think that there will be large scale inflation in future they won't settle for just a few % returns on long dated gilts, as they do, nor for hanging onto sterling.

"Remember printing = inflation. Most of the debts are inflation linked. "

If most debts are inflation linked then having higher inflation won't be of any benefit to the govt and there's no reason for them to want it, is there? It's only if most debts are to be repaid in nominal (not inflation linked) value that inflation is of benefit to the govt.

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nickle

Aug 17, 2012 at 14:01

The markets care about their *real* returns

==========

Is there a market when

a) Annuitants are forced to 'buy gilts'?

b) Banks are forced to buy gilts for capital requirements

c) Ditto insurance companies?

d) The biggest buyer is the government.

=========

It's only if most debts are to be repaid in nominal (not inflation linked) value that inflation is of benefit to the govt.

=========

Correct. However since most of the debts are hidden - pensions - off the books, they think they can inflate to do this. That's why getting the details of the true debt into the open matters.

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M Artian

Aug 17, 2012 at 14:05

Arithmetic lesson.

2% pa. compound interest on £100 over 10 years gives a return of ..

£100 times 1.02 to the power of 10 = £121.90

-2% pa. compound interest on £100 over 10 years gives a return of ..

£100 times 0.98 to the power of 10 = £81.71

Algebra lesson

x % pa. compound interest on £A over n years gives a return of ...

£A times (1 + x/100) to the power of n.

There's a useful little formula for your Blackberry.

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Tony Peterson

Aug 17, 2012 at 14:18

It is pleasing to see, M Artian, that you have decided to learn a little basic computation after your first goofy and patronising posts.

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M Artian

Aug 17, 2012 at 14:30

Praise indeed.

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Jonathan

Aug 17, 2012 at 14:33

ND,

"Most of the debts are inflation linked" - Not true, the government sells them with a fixed interest and the original price of the bonds is repaid on maturity. One of the things that is linked to RPI is the BoEs staff RPI index linked pensions so they don't care about inflation.

"it's perfectly possible to run a QE program without the govt issuing any new debt at all." - Hahaha, when were you born? I thought you'd been around since longer than yesterday. Perhaps you could name a case when this has happened?

" If the markets thought that QE was even a fraction of the way towards what is being said here [Zimbabwe] then the pound would be going through the floor and long term interest rates would be sky rocketing. "

Don't forget that The Fed and Euro are also printing a lot of money. The pound is falling against other currencies.

If you had something (government bonds) that should be worth a low value but you know someone else (the government a.k.a BoE) would buy it from you for a lot of money it would be worth stocking up on them to sell. It's a false market for gilts.

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ND

Aug 17, 2012 at 14:36

M Artian

Thank you for your arithmetic and algebra lessons, however you have ignored the basic error I pointed out to you earlier.

The effect of 2% inflation over a period is *not* the same as compounding -2% over the same period. Try it with a large number, say 100% over just 1 year, to see why.

100% pa. compound interest on £100 over 1 years gives a return of ..

£100 times 2 to the power of 1 = £200. I.e. prices have double and the value of £100 has halved

-100% pa. compound interest on £100 over 1 years gives (according to you) a return of ..

£100 times 0 to the power of 1 = £0. The value of your money hasn't halved, it's gone to zero!

Quite simply you can't compound the negative to get the effects of inflation. When dealing with inflation and compounding you must always use division, not subtraction. In your second formula instead of:

"£100 times 0.98 to the power of 10 = £81.71"

You should have:

£100 times (1/1.02) to the power of 10 = £82.03

Which is the same as taking the reciprocal of the first result. £100 * (100/121.9) = £82.03

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ND

Aug 17, 2012 at 14:50

Jonathan,

Re "Most of the debts are inflation linked", if you look back you'll see I was quoting nickle and pointing out that IF that were true then it would be a point against his argument that the govt wants inflation. I don't know if it's the case or not, but as you and he seem to disagree on the underlying statement and as you seem to now have decided to include derision in your responses, I'll leave you and he to argue it out amongst yourselves.

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nickle

Aug 17, 2012 at 15:00

"Most of the debts are inflation linked" - Not true, the government sells them with a fixed interest and the original price of the bonds is repaid on maturity. One of the things that is linked to RPI is the BoEs staff RPI index linked pensions so they don't care about inflation.

===========

Most of the debts are inflation linked. Your erroneous assumption (along with most politicians and the media), is that debt = borrowing. More on that in a bit.

When it comes to Gilts, last time I looked, 222 bn out of 1,000 bn was inflation linked. As you also point out, the BoE whose remit is to control inflation has bet their pension fund that they will fail. The biggest insider trading scam going.

Now on the debt = borrowing.

If I'm a bank and I take a deposit from you, I have a liability or debt to repay you. That appears in my books. The same with companies and their pensions. They have a liability for the pension. Except the government uses the Bernie Maddoff approved method for hiding their pension liabilities. They just don't report them in their accounts. Those pension liabilities are inflation linked. They are a debt. They are massive.

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Paul 2

Aug 17, 2012 at 15:31

@ nickle

Re the massive pension liabilities that the government has in one form or another, it is always open to them to tax the inflation linked element of these pensions at a higher rate, either precisely or in a broad brush way.

This would be uncomfortable for any government to do and probably impossible for a Labour government to do, given the amount of votes the Labour party counts on getting from public sector employees.

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Wiggy Wiggy

Aug 17, 2012 at 15:50

They say you get the politicians you deserve so we must have done something pretty bad. The modern politician is so corrupt self serving and unprincipled it's a wonder they get elected - why are we so dumb?

We always believe that corruption is something that affects other countries and yet its here too in all forms of government, the banks and in most big companies. Our moral standards have declined as we become more and more under the control of spin doctors marketing departments and other charlatans.

Someone said recently about City Regulation that our problem is not that we don't have the laws to do it - just that we don't bother to enforce them, so why not?

We need a fresh start with new leaders and new ideas - we cannot afford to go along with all this hogwash about QE and QT whilst all that is really happening is that private debts have become public ones. Wake up Britain before it's too late!

Oh and before I forget we need a decent press and media that is not in the pocket of people pulling the strings and who are content to spoon feed us such mind numbing drivel that we become too apathetic to do anything other than go down the pub ,watch tv and worship football and footballers.

Oh dear what a country we have become!

If you want to start to find out what is going on look at www.zerohedge.com and then watch Max Keiser on RT or you tube or at www.maxkeiser.com

Then perhaps we can start to change things for the better.

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nickle

Aug 17, 2012 at 15:55

Tax or default (full or partial), it amounts to the same effect on people. That's the point. They aren't going to have a choice.

Inflation doesn't work, because they are inflation linked. Defaulting by changing the contract unilaterally to say no indexing, then causing inflation, or as you say, just taxing them, has exactly the same effect on people. It makes them poorer.

Now, if you total up all these hidden debts, its clear they can't pay them because they can't tax enough.

The implication is that its going to be defaults.

I can also see the state pension being means tested.

They are going to abolish the state second pension.

The increase to 140 quid is a sop anyway. The reason is that 140 is the MIG (minimum income guarantee. Pay 140 and the MIG disappears. For lots of people the 140 quid state pension means no change at all. Not a huge saving there, particularly because its going to come from the abolishing of the state second pension. Yet another raid.

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Paul 2

Aug 17, 2012 at 16:26

@ nickle

I think that government funded pensions can be taxed 'enough' because they can be taxed at source. Tax avoidance is difficult, if not impossible.

However they may use other means, as you say.

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M Artian

Aug 17, 2012 at 16:52

Arithmetic lesson

Rubbish.

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Tony Peterson

Aug 17, 2012 at 17:09

M Artian

Of course ND is totally accurate. A 2% rise in inflation is not the same as a 2% fall in purchasing power.

You do need to pay a little more attention in class.

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roger cole

Aug 17, 2012 at 17:52

(or go back to Mars? sorry my little joke ...)

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nickle

Aug 17, 2012 at 19:05

I think that government funded pensions can be taxed 'enough' because they can be taxed at source. Tax avoidance is difficult, if not impossible.

=============

Correct, they can get people by taxing at source.

However, what they can't solve is that makes people, and lots of them, destitute. Many cannot even live off the state pension, so they are on benefits on top. Add on the MIG, HB etc, and its 12K a year tax free at a minimum. Plus 35% of the NHS goes on the elderly, plus home care.

It's a recipe for a disaster. Some politicians know this, and most have stuck their heads up their own proverbial and are avoiding any discussion.

Hence the question of fraud. Taking money knowing full well you can't fulfill your part of the bargain. It's fraud.

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M Artian

Aug 17, 2012 at 19:23

We were talking about compound interest, as I recall.

Here on mars we don't have inflation because nobody knows how to print money.

My formula is correct. You are wrong.

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Tony Peterson

Aug 17, 2012 at 19:49

Here on earth if your income goes up 10% and you then are subject to a 10% pay cut, you end up 1% worse off than you were to start with.

On Mars do different rules apply? Or is ignorance, stupidity, arrogant bloody mindedness just as common there as it is here?

There's nothing wrong with your formulas, little green man. It is just that you are applying them incorrectly.

ND is absolutely correct, and you could actually learn something from him if you took the trouble to try to understand him.

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M Artian

Aug 17, 2012 at 20:40

Here on Mars, we don't necessarliy apply pay cuts and pay increases on the same day. So if I earn £A from day 1 of our Martian Year and get a pay increase of 10% and a pay cut of 10% on the final day of our year, then I will have earned £A.

If on the other hand my Martian Trade Union people have been with the faries,

and we agreed these changes from Day 1, then I will have earned

£A (1-1/10)*(1+1/10) = 0.99A

as you say.

It's interesting. If we use x for the fractional decrease and y for the fractional

increase and assume both changes take effect from Day 1, then my pay at the end of the year will be

£A(1-x)*(1+y)

So I will only be better off if ...

1 + y - xy - x is greater than 1.

I must mention this to my Trade Union rep, but since we don't have inflation here on Mars we don't have pay rises either.

Let ND speak for him/herself. We were speaking about compound interest, and even Wikipedia will agree with me.

I am right and you are wrong.

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Jonathan

Aug 18, 2012 at 11:07

re: 1 + y - xy - x, in the example given x=y so it simplifies to (1 - x^2) which, unless you get paid in complex numbers on Mars, is always less than one for any non-zero x?

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roger cole

Aug 18, 2012 at 12:11

Keeping this nicely on topic, women are from Venus - anyone out there? Joking of course and only gently ... Personally, I don't think the mathematics matters *too* much in this debate. Often, approximations will serve, I recall (a long time ago now!) thinking the original author's maths was wrong when he did a simple interest calculation not compounded. It didn't really alter the thrust of his argument. But that said, how on earth can a financial journalist hope to be credible with such a poor grasp of arithmetic?!

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keith fowler

Aug 19, 2012 at 07:48

I would vote for Rose G for Prime Minister as she very good perception .

How about our Minister Hunt and his relationship with Murdock.

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Paul Eden

Aug 31, 2012 at 09:49

The CPI may indeed grow grow faster further down the line than RPI, depending on the varying movements in housing and the economy. It is because the rate chosen to gauge increases in pensions and other benefits is so significant for so many that an independent group of economists should have the final say as to which rate should be chosen for uprating benefits. And perhaps they should review periodically whether the rate chosen should be retained or changed according to the interests of pensioners and others on low benefits.

The government has a vested interest in minimising costs to itself - that interest is what makes people dubious about the correctness of its decisions. If the choice of CPI over RPI does have a big adverse impact on pensions, then future pensioners 25 years from now and notwithstanding the introduction of the new flat-rate pension, will be as badly off as present pensioners.

Politicians will always argue that there is no more money! It is laughable. They throw money away on aircraft carriers that cannot be used, on a computer system for the NHS that does not work. Overseas aid is proudly increased substantially because politicians tell us all we are so rich...only recently we see India given £280 million...India is spending £50 million on a space mission to Mars next year and is ordering frigates carrying cruise missiles from Russia. Nice isn't it?!!

Bank rate changes have been placed in the hands of the Bank of England and I think future governments should have less power where they have such strong vested interests that will make them act unfavourably towards different groups.

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nickle

Aug 31, 2012 at 10:11

If the choice of CPI over RPI does have a big adverse impact on pensions, then future pensioners 25 years from now and notwithstanding the introduction of the new flat-rate pension, will be as badly off as present pensioners.

==========

Well, we can tell what impact the government is expecting.

It's dropped its estimate of the civil service pension liabilities (not reported as debt), by 25%.

You can also look at the cost yourself. CPI is about 0.5-1% below RPI.

So compound that over the average retirement age, and you get a rough estimate too of the loss of money. About 25%.

50 million? Chicken feed.

The true debt of the government is around the 7,000,000 million mark.

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Jeremy Bosk

Aug 31, 2012 at 10:50

In 25 years time, pensioners will outnumber the working population so they will vote in whichever government promises them the biggest short term pay off. Generally, pensioners have less reason to care about the long term. Altruism, caring for grandchildren or the planet come second place to keeping warm.

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nickle

Aug 31, 2012 at 12:05

Well, with increases in the state retirement age, part of that is being address. However, your point about the demographics is correct.

However, just because you vote for a Government doesn't mean that government will do what you want, or even be able to do what you want.

That's why quantifying all these debts is the important question to ask.

7,000 bn of debts (present value), on tax revenues of 570 bn. 12-13 times geared. The debt goes up with inflation.

Now there are those pesky problems, spending. No doubt those pensioners will want the NHS, free bus passes, roads, the police to stop the youngsters from rioting. Schools to keep them occupied. That means the money not committed to paying their pensions is smaller, and, ah yes, the government can't pay it.

Inflation doesn't work either. You can't inflate your way out of inflation linked debts.

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Jonathan

Aug 31, 2012 at 15:07

Jeremy Bosk

My guess is in 25 years time the retirement age will be 75 so pensioner will not outnumber the working population and many of them will be too infirm to vote.

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nickle

Aug 31, 2012 at 16:39

So 10 years on the current pension age.

Hmm for a median worker, on 26K, lets look at what they would have lost by that, in today's value of money.

19K (what they would have got for their NI in the FTSE) * 10 years - 190K

10 Years of employment related NI contributions at 9K a year, 90K

Total is 280K.

Given their share of the current true government debt is 230K, I suspect you might be right.

However, you might need to factor in 10 years on benefits from 65 to 75.

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Jeremy Bosk

Aug 31, 2012 at 18:06

Inflation linked or not, the debts will be made to disappear when they become too inconvenient.

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nickle

Aug 31, 2012 at 21:10

Exactly. Disappear = default.

So if you have 'invested' your retirement with the state, you are going to be done over.

Forget the elderly voting themselves rich, they are going to be the target.

1. Watch out for the tax raid on private and company pension funds. For the public good obviously.

See Hungary and Argentina for the scam

2. Property taxes - you can't move the house - so its hard to evade. Clegg is a good example.

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