Pensions White Paper

By PAUL HOBAN 26/05/2006

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This week saw the Government publish its long awaited Pensions White Paper, which represents its first serious attempt at solving the Pensions Crisis.

The fundamental problem is that the combination of an ageing population and increasing life expectancy is placing an intolerable strain on the State Pension. While there are currently three workers to fund each pensioner, by 2050 it is expected there will be just one. To make matters worse, far too few individuals are saving adequately to provide a comfortable retirement income.

The White Paper generally endorses the suggestions made by last December’s Turner Report (published by the Pensions Commission), the key proposals being:

Raising the retirement age from 65 to 68
The State Pension age is now due to increase to age 68 from 2044 (rising to 66 from 2024 and 67 from 2034). Raising the retirement age is inevitable, and if life expectancy continues to increase then we would not be surprised to see it increase well beyond age 68 by 2044. Over the last 20 years the life expectancy for a male aged 50 has increased by 4.5 years to 78* (increased by 3 years for a woman to age 82). If this continues at the same rate then by 2044 male life expectancy at 50 could have risen a further nine years, more than outweighing the proposed retirement age increase. We also have concerns as to whether 65 year olds will be able to find employment easily; if not the cost of supporting them via the benefits system could cost the State more than a pension might have.

Restoring the State Pension earnings link
The Thatcher Government severed the link to earnings in 1980, choosing instead to link annual State Pension increases with prices. The Government plans to restore this link by 2012, subject to affordability, which on the surface is good news as earnings tend to rise faster than prices. However, restoring the link has to be paid for, and if the increased retirement age proves insufficient then this move could leave future Governments having to raise taxes to pay for this.

Introduction of a soft-compulsion National Pensions Savings Scheme (NPSS)
Employees will have access to a new low-cost personal pension account from 2012, being automatically enrolled unless they choose to opt out. Employees will contribute 4%, employers 3% and the Government 1% (via tax relief, higher rate tax relief will also be given where appropriate). While this will actively encourage everyone to make provision for retirement above the State Pension, there are potential flaws:

• An 8% total contribution may not be enough. A male aged 25 earning the national average full-time income of £22,400*, who enjoys 8% pension contributions between age 25 and 68, could expect to retire at 68 on a pension of £13,200** (in today’s terms), just 25% of the projected final salary (£52,500).
• Many employers, unhappy at the prospect of higher employment costs, will simply pass on the 3% cost to employees via a reduction in salary and/or other benefits. Employers who currently contribute more than 3% into a pension for employees could be tempted to cut back to this new level.
• The Government has a poor track record at encouraging individuals to save (Stakeholder being a good example), so will individuals simply choose to opt out in droves?
• Who will pay for employees to receive advice on investment choice? History suggests the public are mostly unwilling to pay for advice.
• If investment choice is restricted to trackers, is it a good idea for the nation’s retirement prospects to hinge on the share price performance of a handful of large companies? (The 10 largest companies quoted on the London Stock Exchange represent around 50% of the FTSE 100 Index).
• Although there’s no doubt individuals need to save more, saving rather than spending could adversely impact the economy.

Cutting the number of years needed to qualify for a basic State Pension to 30
Currently a male must work 44 years, and a woman 39 years, to enjoy a basic State Pension. While reducing to 30 years sounds attractive, it will have little impact in practice given the proposed increase to the retirement age (as the majority of the population will be working longer anyway). However, it should help those who take long maternity or career breaks and foreigners who emigrate to work in the UK at least 30 years before retirement.

While the NPSS proposal is encouraging, Bestinvest still believes that a more practical solution to the decline of both final salary schemes and savings inertia would be to introduce a state sponsored scheme which removes investment risk for individuals, by allowing individuals to purchase an income starting at a certain date in future. For example, a 45 year old contributing £1,000 now could receive a £200 income for life from age 65. This avoids the whole issue of investment risk and performance, charges and public mistrust of pension policy and providers. It could be administered through National Savings and the scheme should involve no additional cost to the Exchequer as it will simply be an alternative form of Government borrowing.

The White Paper is a step in the right direction, but it reinforces our view that no Government will be as tough as it needs to be for fear of losing votes. We also believe that unless there is cross political party agreement that future Governments will support these proposals, then the public will continue to distrust any long term plans for fear a new Government will simply change them. The Government’s self-congratulatory stance upon publishing this Paper is also hypocritical; we should not forget that Gordon Brown wielded a sledgehammer to pensions back in 1997 when he abolished pension funds' ability to reclaim the tax credits attached to UK dividends.

* Source: ONS
** Assumes salary grows 2% above inflation, annual investment returns are 4% net of inflation and charges and the pension fund is used to buy an index-linked joint-life 10 year guarantee annuity at age 68 (annuity rate based on current FSA average).

Values delayed by at least 15 minutes.
Source: Financial Express