The Government this week published a second White Paper outlining their plans to deal with the Pensions Crisis. The timing is rather ironic, as Gordon Brown had further destroyed public confidence in pensions just a week earlier by announcing a u-turn on Alternatively Secured Pensions and Pension Term Assurance (see our Pre Budget Report article).
| "The new White Paper focuses on a soft-compulsory pension scheme for employees from 2012." |
The latest White Paper focuses on ‘Personal Accounts’, the Government’s proposed soft-compulsory pension scheme for employees which is due to be introduced in 2012. These will affect all employees aged over 22, as they will be automatically enrolled into the scheme and will need to contribute 4% of their salary unless they choose to opt out. In turn, employers must contribute 3% and the Government will contribute 1% via tax relief (higher rate relief will be given where appropriate). Annual contributions are to be capped at £5,000 (£10,000 in the first year) and based on earnings between the ‘Primary Threshold’ and ‘Upper Earnings Limit’ for National Insurance Contributions, currently around £5,000 and £33,500 respectively.
The Paper suggests Personal Accounts will offer three investment options, with shorter term annual charges of around 0.5% and longer term 0.3%:
- A default fund that invests in a range of different assets.
- A handful of low cost bulk-bought funds.
- A wider range of funds including ethical and brand name options.
It is also proposed that transfers in or out of Personal Accounts will not be allowed, which could prove an issue if the range of funds on offer is narrow.
In general we think Personal Accounts are a welcome move, as they will actively encourage all employees to make provision for retirement above the State Pension, but there are 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, may simply pass on some or all of the 3% cost to employees via a reduction in salary and/or other benefits. This has already occurred in Australia, where a similar system has stifled wage increases.
- 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 (which is likely given the low target annual costs), 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).
- A large proportion of the target market is probably in debt. Should they be clearing these first given debt interest is likely higher than potential pension investment returns?
- Although there’s no doubt individuals need to save more, saving rather than spending could adversely impact the economy.
Personal Accounts will probably improve matters, but fall short of making a significant contribution towards solving the Pensions Crisis. What the Government really needs is a consistent policy across all potential retirement savings vehicles. Their approach to date has been haphazard and done little to restore the public’s faith in pensions as a worthwhile way to save towards retirement.
| "Restoring the ability to reclaim dividend tax credits would have been a far simpler way to encourage saving..." |
It may be co-incidence, but Government estimates suggest that Personal Accounts will lead to £4-5 billion of additional annual pension savings – a similar figure to the ‘stealth tax’ that Gordon Brown levies on pensions each year by preventing the reclaim of tax credits attached to dividends. A quick u-turn on the latter would be a much simpler way to boost pension contributions.
* 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).