Pension Erection

Damn, did I bring SIPP protection?

Damn, did I remember SIPP protection?

The night’s are fair drawing in, and so is the year. Only fifty sleeps to Christmas, or something like that. As the year draws to a close, I start looking at my financial position more closely and comparing with the previous year. I like putting things “in order” and in comparison.

This year, because I have time, I decided to have a look at our pensions. I have three – one defined benefit, one defined contribution, one SIPP. My wife, having moved across several NHS and Council authorities, has five. Five! Of mine, two are online and can be checked daily, if you’re so inclined, telling you what’s in your pot. The other, I have to write away for a projection. My wife has two online and three that I’ve had to write for a projection on.

So far, so straightforward. Oh I wish. When do we want to take them? All three of mine I can take at 55. My wife has four she can take at 60 and the fifth at 65 (although I have still to confirm this, it might be 60 too.) On my defined benefit, and on the others, I can take the tax free lump sum and a reduced monthly payment. Or not. My wife also has this option. That’s quite a few permutations to juggle and calculate.

Of course the figures jump around too. One of my pension pots is currently about ten percent under where it was eight months ago, making an almost fifty grand difference. What will it be worth three years from now when I’m planning to take it? How long is a piece of string? Do I project forward at 4%, 6% or 8%. Or do I assume it will not increase at all in real terms from where it is today?

As for my wife’s pensions, I need the projections as I’ve no idea, on all five, what the numbers might look like five years down the road from when I last checked. Never mind a further eight years from today when we might actually take them. What margin of error should I use when I receive the quotes? If a defined contribution pension says it looks like it might pay out £5,000 a year, should I assume £4,500 as gloomy downside or £5,500 as a sunnier alternative? Probably best to stick with their number, whatever that is.

So, by the end of next week, hopefully, I’ll maybe have eight pension projections across various age “scenarios” of 55, 60 and 65 and two combinations on each with lump sums or not. My mind boggles to think how many models I could make out of this bunch of options. And this is before I start to think about drawdown versus annuity on some, none, or all of them.

Okay, keep it simple. I think the first filter to apply is straightforward –  do I take the tax free lump sums? “Yes”, is the quick answer on that, because anything tax free is worth having. I can take them as initial income and shovel the remainder into ISA’s over the years that the cash lasts. Or, could I give to my wife to put in a SIPP that she can claim tax back on when she reaches 60? Whatever, I take the tax free cash.

Tax. If there is one financial subject that defies simplicity surely this is it?  One simple fact, however, is that in my humble opinion I have paid enough over the years. For almost thirty years I was chipping in over forty percent of my salary to the Treasury, so I really don’t want to put in much more. As far as I can see, that means I have to be taking out an income of about ten grand in pensions (as can my wife) before we hit the basic tax rate. Is there a way I can increase that income on a tax free basis? Probably, I hope, but that’s going to take some further research on Monevator on my behalf to try and find out. Nevertheless, please feel free to give me some pointers in the comments if you have any ideas about minimising tax payments on pensions! At this stage, as far as I can see, paying some tax looks like an inevitability.

All of these are my First World Problems, and I’d be first to admit I’m lucky to have them. Or is it “luck”? At twenty two years old, I signed up on my first day at work to the company Defined Benefit scheme because my boss basically told me it would be really stupid not to. That was possibly “lucky” and I owe him a big thanks for that. If he’d told me it would cost £200 a month off my salary, I think there’s no way at that age I would have done it. About three years later, at a pensions seminar arranged by my work, I realised the importance of what I’d done and resolved to keep salting the cash away at the maximum contribution rate in any job I took. So that was more “knowledge” than “luck”. My wife is similar, although she can’t explain why she took pensions from the day she started working in the NHS at seventeen year old. She just knew it made sense and did it.

Building pensions aren’t, and often can’t be, for everyone. I like the old Chinese saying, “The best time to plant a tree was twenty years ago. The second best time is now”, but when it comes to pensions, “The best time to plant a tree was twenty years ago, the second best time was nineteen years and fifty one weeks ago.” These days you have more choices and much more information. Company pensions have seen better days and property often feels like a better bet. If only the Government would stop piddling around with ISA’s we might put more trust and money in them – we would if we could, no doubt.

In the end (which I’m nearing) when it comes to money, we just need to save what we can, when we can and in whatever we can. It’s difficult to go wrong with that.

30 thoughts on “Pension Erection

  1. There is a recent post in Retirement Investment Today on maximising all of the new various tax free allowances and also an article in the online edition of the Daily Telegraph

    Not by accident these allowances are tailor made for the retired since those comprise the bedrock of conservative voters

    There was also a similar article in one of the city boy blogs I don’t follow closely, Under the Money Tree or the escape artist

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    • Thanks for the hat tip Neverland. When I sat down and actually worked out all the ways I could avoid (not evade of course) tax in FIRE I was somewhat surprised. The UK is a high tax country (and boy do I feel it as I race towards FIRE) but for a retiree it currently looks like one of the better Tax Havens of the world to me. Then on top of that and unlike the official Tax Havens you then get free healthcare on top. Thus my possibly evocative post title.

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  2. Hi Jim,

    Congrats on all the pensions – it sounds like you have made decent provision. I have 6 myself, and my girlfriend has 4, so we’re in a similar boat.

    I just turned 55, so I have been looking into the best way of getting the money out. Apart from the 25%, you have to pay tax. That’s the price of getting tax relief on the way in, I’m afraid.

    It’s not as bad as it sounds though – you can draw out £56K pa and only pay 11% tax, leaving you with £50K to spend / put in an ISA.

    More details here: moving into drawdown

    Mike

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    • Thanks Mike, I had a quick scan of your site and will go back to it. Lots of good information for me there. I liked what I read on how you pay 11% tax – it was really clear and easy to follow. If only other financial websites could Keep It Simple!

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  3. Hi, I’m going to grab what I can immediately – up to the tax-free limit, then bleed the rest off as & when possible to pay no tax on – once in my hands, I can invest it & more importantly have control/liquidity so the next politico can’t change the laws to seize it on a whim.

    I have paid plenty of taxes in my time, more than I will ever get back off the state, [that is virtually guaranteed now that the state is being dismantled piecemeal anyway] so feel no need to contribute any more. My neighbours I have lived next to for years have a multi-generational household containing several adults none of which I have ever seen work – to look at, they are the happiest people I know. I wish them well, but decline to fund anyone who chooses not to bring something to the table under the social contract. Anything I couldn’t afford to pay for myself in my life, (from money I earned) I had to do without, so my philosophy is that it should be equal therefore in that regard.

    If I had my pension split between several providers like you though, I would definitely want to consolidate them under one for convenience. It wouldn’t have to affect the level of risk via reduced diversification either if you chose a provider that gave access to various investment options. I used a table/article on the Monevator site that compares providers, helps with explaining the criteria that are important & picked out a fund that covers many good companies. I know that’s a managed fund …..& equities alone are still putting all your eggs in one basket, but I felt I still had enough time left to take that gamble & had also done a lot of research on that fund – I keep a constant eye on it though & it is still doing good.

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    • Thanks Survivor, I would love to consolidate my wife’s five council/NHS schemes, but I’m not sure if this can be done. I’ll have to trawl through five sets of paperwork, and I’m not sure if I’m up to the task!

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  4. Hi Jim

    Here’s that article that Neverland mentions which might be useful:

    http://www.telegraph.co.uk/finance/personalfinance/pensions/11979259/How-to-pay-yourself-a-98100-income-salary-without-paying-any-tax.html

    I signed up to my DB pension scheme following the advice of my older sister – she basically said that if there was a company pension, just join it so I did – I was 26.

    I only found out after paying into it for 16 years that it was a DB scheme and I realised how lucky I was and how grateful I was for my sister’s advice.

    I guess it was just as well that even during my dark old days of being in massive debt, it never crossed my mind to stop paying into my pension. I know for a fact that had I stopped those payments, that money would not have gone towards paying down debts.

    Good luck with sorting out your pension pots – it looks like you can take advantage of some decent tax breaks on offer and hope that future governments don’t tinker too much with them!

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    • Thanks for the link Weenie. It’s great the amount of information that’s out there and even better when you’ve got helpful people pointing you straight to it! As I read the articles I wonder for how much longer the Government are going to keep their hands off the savings of those of us who have planned for the future. Not long, I suspect.

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  5. Hi, regular reader and great blog!

    “I think the first filter to apply is straightforward – do I take the tax free lump sums? “Yes”, is the quick answer on that, because anything tax free is worth having.”

    For your SIPP and defined contribution scheme, sure. But be wary of applying the same logic to your defined benefit pension (or those of your wife). It depends on the schemes – with some the tax-free cash builds up separately, but with others you can only take tax-free cash by giving up income (which seems to be the case for yours). The rate at which you convert income to tax-free cash (the “commutation rate”) is often so unfavourable that you are likely to be (much) worse off overall (after tax) taking the tax-free cash than just sticking with a higher level of taxable income. The defined benefit schemes themselves know that tax-free sounds attractive and getting your hands on some cash right away is tempting, and use unfavourable commutation rates to improve their balance sheets (at the expense of those tempted).

    With eight different pensions across the two of you, a mixture of defined contribution and defined benefit schemes, and the total value of your pensions potentially being at a level that you need to be thinking about Lifetime Allowance planning as well (hard to say just based on this post alone), your circumstances are complex (and heck, pensions are just complex full stop!).

    So I would be wary of not seeking proper financial advice before you get to 55 – or at the very least getting guidance from PensionWise (defined contribution/SIPP only) or The Pensions Advisory Service (all pensions). You can get a good adviser just to advise on your retirement income strategy and not on the investments if you feel comfortable with selecting those yourself.

    Your pensions are of the level that several hundred pounds spent on getting high quality advice on the overall strategy could be money extremely well spent compared to trying to do it yourself (without necessarily understanding all of the implications) and potentially messing it up. Twenty, thirty or forty years in retirement is long time for the financial implications of any DIY mistakes to compound over.

    However, I will say that it sounds like you have done some very good planning over the years though to be in the position that you are in, fair play to you!

    Full disclosure: I am an Independent Financial Adviser.

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    • Thanks for the feedback and some excellent food for thought. One of my close friends is a pensions adviser and quite highly qualified, seemingly. Unfortunately, being British, I baulk at giving him my financial details! Strange, isn’t it? I mean, I probably will seek professional advice soon as it’s such a difficult area (and once I admit to myself that I’m not smart enough to know or learn all the answers.) And I should go to my friend, really, whom I trust. But it’s not just pensions that are complex!

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      • I think when you see the standalone fee a pension adviser wants, you may reconsider. I would think it will several thousand pounds!

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  6. Hi Jim,

    That sounds like a real mountain of paperwork to go through – I hope you have enough strong coffee! Seriously though, congratulations on building up some excellent savings and being ready for retirement. I’ve been consolidating my pensions as I go through my career, but in my next move I will also start up a SIPP so that I split my risk. I’ve got another 17 years before I can take my pension (as it stands, I expect the government will change that), so I am actually looking at how best to save for retirement, especially if I want to retire before I can access my pension!

    Spot on to take the tax free where you can (although John has a very valid point – if there is a big impact on you DB pension, it may not be worth it!).

    Good luck!
    London Rob

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    • Cheers Rob and good luck too. I hate admitting that luck comes into it, but what else can you allocate government policy to? They may well, I fear, decide that the minimum pensionable age should move to sixty. I believe it was back in 2010 that they shifted it from 50 to 55? They’ll do it again and I read somewhere they were going to float the proposal back in the last budget, but didn’t. They need to keep us working to collect the tax. Mind you, as I’m finding out, in your fifties finding work is no walk in the park!

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      • Access to a sipp is already linked to state pension age an the earliest access age is going up from 55 to 57 in 2028. This process will accelerate imho

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      • Hi Jim,

        Thanks – and you are right when it comes to government policy – originally everything was going into Pensions, but I am going to get sh@fted by all the changes. As you say they did bump it to 55 from 50 (when I first started setting my more realistic aim of retirement), and as Neverland says, they are going to link it to State Pension Age – 10 years. With 27 years to my new State Pension Age, I expect them to push it back further, so I need to sort out other options for investments. I am sure they will change those in time to, so lets see what happens!
        Cheers,

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      • This is the big worry for anyone wanting to retire early. Scaremongering as done by Duncan Buchanan, president of the Society of Pension Professionals http://www.ft.com/cms/s/0/98de7dec-8962-11e5-9f8c-a8d619fa707c.html ignores the concept that people could have money in other areas, and could force people to burn out their ISAs in their early 60s and then pay greater rates of tax on their pensions. Hopefully a government that removed drawdown limits won’t reintroduce them, but a nanny state is always a worry. Any sign of this idea getting traction, and we must campaign against it.

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  7. > If a defined contribution pension says it looks like it might pay out £5,000 a year, should I assume £4,500 as gloomy downside or £5,500 as a sunnier alternative?

    All your DC pensions are the same class of wrapper, though of course what is inside the wrapper may be different types of investment. Find out what is in those wrappers and what the platform fees are. And shift if necessary, checking for exit fees. It’s usually cheaper to sell and transfer as cash.
    Then basically follow Monevator’s passive index articles, and qualify the income as roughly 4% of the capital value per annum.

    The rule with DB pensions seems to be never draw them earlier than NRA, and generally don’t commute pension for lump sum unless you are in ill health. for an early retiree the mix of DC and DB pensions is good – start taking the DC pension as early as you can (to minimize tax) and run the capital down until your DB pension NRA.

    w.r.t lifetime allowance you can compute that for a deferred DB pension as 20 times the value at NRA plus any separate lump sum

    https://www.gov.uk/tax-on-your-private-pension/lifetime-allowance

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    • Hi Ermine, yes I’d dearly love to know where my wife’s pension money is going and might look into it. In my own working days, I tried to give my team informal advice on their pensions (if they had them) because we could self select funds for our money. Obviously I’d point them toward a balance of cheap trackers, one UK, one Europe, one US, one Asia etc.. I think the most positive response I ever got on this subject was utter blank indifference. Oh well, I tried!

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  8. In my case with a £5k DB pension at 60 and £7k state pension at 67, I reckon I’ll be using all my personal allowance in later years anyway, so I will be drawing down my SIPP at just under the 40% tax level from the start. After living expenses, max out the ISA limit and put the rest in conventional investments.

    Dividends and capital gains in a pension in drawdown are taxed as income when you finally get them, in an ISA there is no tax, in conventional investments there will be a separate dividend tax allowance you can combine with the capital gains one, giving more allowances, so you are better getting the money out ASAP (the lump sum complicates things as its growth is tax free, but I’m ignoring that here)

    So under 60
    withdraw 43k from SIPP, use 11k personal allowance, 5k dividend allowance, 1k interest, 11k CGT allowance and invest 15k in an ISA.

    60-67
    Take DB pension, withdraw 37k, rest as above

    67-
    take DB and state pensions, withdraw 31k, rest as above

    Obviously the SIPP will run out quickly at those rates, but by then you will have the money stashed tax free in ISA, or in conventional investments where you are no worse off. Only be less aggressive with withdrawls if you think you won’t be using your income tax allowance in some years.

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    • “Dividends and capital gains in a pension in drawdown are taxed as income when you finally get them, in an ISA there is no tax, in conventional investments there will be a separate dividend tax allowance you can combine with the capital gains one, giving more allowances, so you are better getting the money out ASAP (the lump sum complicates things as its growth is tax free, but I’m ignoring that here)”

      Let’s suppose you have £15,000 in a pension and withdrawing this incurs basic-rate tax (ignoring the tax-free cash as you suggest, because this doesn’t affect the comparison below). With tax-free growth and reinvested income, your investments double over, say, 10 years.

      So you take it out, pay tax of £3,000 and have £12,000 to invest. You put this in an ISA. After 10 years it is worth £24,000, which you can withdraw tax-free.

      If you leave it in a pension, your £15,000 is worth £30,000 after 10 years. If you withdraw incurring basic-rate tax (perhaps over 2 tax years if necessary), you pay tax of £6,000, leaving you with…£24,000.

      This shows Taxed x Exempt x Exempt (TEE) is exactly the same as Exempt x Exempt x Taxed (EET), all else being equal – i.e. your premise that pensions are tax-inefficient because “dividends and capital gains in a pension in drawdown are taxed as income” is fundamentally wrong.

      But pensions have other advantages, including that they cannot be accessed by creditors if you become bankrupt, they are exempt from Inheritance Tax, your heirs won’t pay any tax at all to access your pension if you die before 75, and if they don’t need to access it immediately, and even if you die after 75, they can leave it in a pension to carry on growing tax-free until they do. These may or may not be relevant to your personal circumstances.

      If you haven’t already got the money in a pension, then you do have to consider the further tax advantages of pensions in terms of receiving tax relief on all of your contributions, but getting tax-free cash when you withdraw, and potentially paying tax in retirement at lower rates than when you made the contributions. Factor these in, and invariably pensions are more tax-efficient long-term savings vehicles than ISAs (which is why the government is considering the generosity of pension tax relief).

      If you withdraw money from your pension to invest into “conventional investments”, then the numbers will be the same as for ISAs in the example above (i.e. no better or worse compared to left in the pension) provided the income the investments generate falls entirely within your savings allowance or dividend allowance (from next tax year) and the gains they generate fall entirely within your CGT exemption.

      But if either income or gains exceed your allowances, then the numbers will be worse because your investment returns will no longer be tax-free, and even if there is no tax to pay, you may have created an additional tax reporting burden. And the other advantages of pension (if relevant) will have been foregone.

      Pension legislation may change, you can’t access your pension until minimum pension age, and you can’t buy certain assets within a pension (which may or may not provide higher returns) – so there are disadvantages. Then again, ISA legislation, income tax legislation and CGT legislation all may change too.

      But under current legislation, and purely from a tax perspective, taking money out of a pension to put it into an ISA or taxable investments is highly unlikely to leave you better off, it may make no difference at all, and it could very easily leave you worse off.

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      • I see your point with TEE vs EET for pensions vs ISAs (except if the higher tax later pushes you into a new band), but ISAs do allow quicker reaction to tax law changes at present. Pensions not being included in inheritance tax seems amazingly generous, and I wonder it it will last.

        But with conventional investments, providing half their increase comes through dividends, half through capital growth, having both 5k and 11 allowances must help compared when combined with the 11k personal allowance

        If with a 5k DB pension at 61, I have conventional shares providing 10k in dividends, 10k in capital gains, I pay no tax (as I can count half the dividends against personal allowance). If I were withdrawing 20k from a pension, I’d pay basic rate on 15k of it.

        While accumulating, the preferential order is SIPP, ISA, conventional, when divesting SIPP, conventional, ISA.

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      • I can see the argument for withdrawing from pensions in favour of ISAs if the bankruptcy / inheritance advantages are not relevant and you worry enough about future changes to pension legislation (relative to ISA legislation). Then it’s tax neutral.

        (Although your pension pushing you into a higher band later can easily be mitigated by common sense tax planning, such as withdrawing over two (or three or four) tax years instead of one. Even once your DB and state pensions have kicked in, you could still withdraw £30,000 a year paying basic rate tax.)

        And yes, still ignoring some of the advantages of pensions, it would be tax neutral to withdraw from pensions in favour of taxable investments – if you can ensure that you remain within the savings / dividend / CGT allowances such that the income and gains are tax-free. But if you don’t remain within those allowances, then it is not tax neutral, it is tax negative.

        Which just leaves future legislation. And I cannot see why you would be more worried about changes to pension legislation than to legislation that might affect taxable investments (e.g. changes to tax on dividends, interest or gains, and IHT unless we are still ignoring that).

        Which changes (to DC pensions) since 1988 have detrimentally affected the masses? The dividend tax credit changes in 1997, the increase in minimum pension age from 50 to 55 in 2011 (and maybe 57 and higher in due course, though this still isn’t law), and scaling back the Annual and Lifetime Allowances recently. The first made no difference once ACT was abolished in 1999 and ISA treatment was brought into line in 2004, the second only really affects FIRE-seekers/the rich, the latter only really affects the “rich”. Any others?

        As far as I can see, the direction of travel has otherwise been one way (positive) because those approaching or in retirement have accumulated a lot of wealth in pensions, are relying on them for retirement income and tax-free cash to repay mortgages and debts, they vote, and the state would have as big a cost to pick up the pieces. And good luck to any government trying to pull up the drawbridge and go back to forced annuitisation or capped drawdown (“Freedom and Choice”, once out the bag, went through more or less unopposed across the political spectrum).

        The constituency with taxable investments is a lot smaller. Dividend taxation has just gone up for most – basic rate taxpayers had no further liability, now it is just £5,000 that’s tax-free – and this was collateral damage as part of cracking down on the incorporated self-employed! I understand wanting to keep your options open. But if tax on dividends or interest or gains change, you can only put £3,600 a year back into pensions – while if pension rules change, do you really think you won’t be able to withdraw from pensions then?

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      • Another way of thinking of this is that if you have conventional investments returning 3% dividends, 3% capital growth in a 2% inflation world, giving you the mythical 4% SWR, you could have 333k of conventional investments (10k dividends, 10k capital gains) and a 5k DB pension and not pay tax. Once you get a state pension that would drop to 166k or so.

        With a 500k threshold each, a householding couple with a 500k house wouldn’t need to worry about using pensions to avoid IHT, but it would make sense for a singleton if they had dependants.

        I think I’d be happier with instant access to that 250k than having it still in a pension.

        I expect tax returns will become inevitable for anyone with investments soon, with the introduction of dividend tax and removal of taxation at source of interest.

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  9. Wow, all these comments, just goes to show what a minefield pensions are.
    I have no idea how much I will really have in my pensions when I get there. At the moment I have 4, one DB which is frozen and ‘should’ pay £12k pa at NRA and three DC which will pay about £500 pa in total if I am lucky and that is if I wait until NRA! One of the DC’s is accessible from 55 but it will be worth nothing, about £80 pa (projected), so that really is not going to give me anything to live off. The others are worth peanuts so those with comments about accessing £50k, I wish I had pension pots that are anywhere near that in value never mind draw as the tax free sum.
    I have always paid into pensions but do wonder why? They are not gaining anything and compared to my other investments they lag behind due to all the fees. Also, trying to consolidate them is hard as none of them will let me transfer without penalties. One DC is not going to offer a drawdown option. So if I want to drawdown, I will have to transfer it – and take a hit with charges!!!
    These pension changes have not liberated the market if you have old schemes were the companies refuse to offer the new rules on the accounts. I am being penalised for saving in the first place….Ha,Ha,Ha..stuck with an old rules product! What a shame, here’s the hit in fees to move your money to a new rules one! Oh, you have lost 30% of the pot value in the process!
    I guess it is better to have something that nothing, but that something is worth less every day 😦

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  10. It seems like pensions & all the other needlessly fiendishly, complicated industries have a good case against them for mis-selling, with their lobbying power though, we probably wont see any justice in our lifetimes, given the timescales of what happened with the PPI & other depressingly common scandals on that conveyor belt.

    There’s a missed opportunity here for the business community, whereby if the first mover in every service industry re-invented the wheel by setting up a basic, honest, transparent good service at a fair price, a lot of people would gratefully give their custom.

    Imagine that, just honesty as the unique selling point ….. how the hell did it get to this point whereby that concept seems as ridiculous as asking for the moon?

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