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A provider pension statement gives you a future fund forecast in “today’s money” terms (after inflation). That doesn’t make it wrong but it does make it confusing for most people.
Pension providers use “today’s money” forecasts. This could mean the growth rate used is 2% per year and the inflation rate used is 2.5% a year. Although the fund is growing each year at 2%, the effect of 2.5% inflation is actually reducing the fund’s value in buying power by 0.5% per year after inflation. Therefore, the forecast shows an imaginary reduced value rather than an actual higher value making it difficult to understand your real future income.
Providers use different rates of growth and different rates of inflation in their statements.
A 40-year-old may have a pension fund currently valued at £100,000 into which no further contributions are being made.
The provider’s statement will be in today’s terms and the “today’s money” forecast might say:
At age 65 (in 25 years time) the fund value will be £87,000 (after inflation ie the buying power today) because it assumes the fund will lose 0.5% per year after inflation.
This doesn’t sound like a good investment…especially if you are unsure what growth rate and inflation rate is being used.
Take inflation out of the equation and in “real money” terms the fund value at age 65 with 2% per year growth will be more like £165,000 (the actual value at 65) – certainly a worthwhile investment, even if the growth rate used is low.
Without understanding the “real money” value it is difficult to understand what your income from the fund will actually be, particularly if you have a number of different pensions all using different forecasting rates.
You can work out your “real money” value from your pension statement using our savings/investments calculator. We have filled out the calculator in the image on the left using our example above to show you what figures to use.
We invest our clients pension funds in sensible, well diversified portfolios. We use a standard net growth rate (after charges) of 5% per year for our forecasting but we can use any realistic rate agreed with our client. We currently assume that inflation is 2.5% per year.
When we report to you, we build up a history of actual growth rates so you can determine whether the standard 5% rate we use is realistic, based on a real history of returns.
We also show you the “real money” figure and the future “today’s money” figure side by side.
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