A step towards a more secure retirement
The Government White Paper, Security in Retirement - towards a new pensions system (published in May 2006), establishes the framework for a new, quasi compulsory, private retirement savings scheme, referred to as ‘personal accounts'. The Pensions Commission, under Lord Turner, had proposed a similar arrangement, which it termed the National Pensions Savings Scheme (NPSS), when it published its report into the current state of pension saving in the UK in November 2005.
The premise the NPSS rests on is that people do not, and will not, save enough for their retirement. This is because, with regard to saving:
❑ people are poor at assessing their financial needs over the longer term;
❑ people are very slow or reluctant to make savings, particularly if they are long term and particularly without any help or guidance; and
❑ people are confused and tend to overestimate the income they will receive in retirement and underestimate the income they will need to meet their financial needs.
The environment in which people have to make retirement saving is very complex. Employees have seen occupational pension provision declining; several changes have been made to the state earnings related pension and the state second pension; the basic state pension has fallen in value relative to earnings; and means tested provision has grown. This makes it hard to understand the true combined value of state and private retirement provision in the UK, particularly for people on low to medium incomes. Some people eligible for means-tested benefits might find they get no value from their private savings at all.
Consequently, introducing the NPSS without reform to state retirement provision was unlikely to be successful and the White Paper appears to recognise this, to a degree.
The NPSS is to be launched in 2012 broadly as the Pensions Commission proposed:
❑ There will be a ‘default' contribution of 5% from the employee (including 1% in tax relief on the contribution) and 3% from the employer. The White Paper proposes that contributions will only be paid on earnings between around £5,000 (€7,335) and £33,000 pa. The Pensions Commission suggested employees should also be permitted to make additional contributions to the NPSS, up to a maximum amount, although the Government has not picked up on this. It is likely this issue has been left to the more detailed consultation into the operation of the NPSS that is to follow later this year;
❑ Employees will be automatically enrolled into the NPSS when they reach age 22, and their pay is more than £5,000 per annum, and when they join a new employer. They will be able to opt out, but their decision will be revised from time to time. This is to help employees manage their changing financial circumstances, while attempting to overcome their reluctance to make long-term savings.
❑ Employer and employee contributions will be phased in over three years. This is to give employers time to adjust the total remuneration package they provide their employees, so as to manage the increase in employment costs.
Employers with occupational schemes that meet certain minimum criteria will be able to use them to substitute for the NPSS. The exact conditions will be included in the further consultation exercise, but are likely to include automatic enrolment, minimum contribution or target benefit levels, and low costs.
The Pensions Commission proposed that the Government should establish a central clearing house to collect and administrate the contributions and their investment. It is this delivery mechanism that inspired most debate about its proposals. For example:
❑ the Association of British Insurers (ABI) would prefer insurance companies to be used to provide the NPSS; and
❑ the National Association of Pension Funds (NAPF) has suggested ‘Master Trusts' could be established to act as providers.
Both these suggestions would introduce competition into the market for NPSS savings, which could help keep costs down and encourage good service standards.
However, the Pensions Commission argued that the only way to keep costs down is to avoid the need for providers to market themselves. This requires a centrally mandated arrangement which can manage the selection process for investment managers and annuity providers. It believes its proposed arrangement would be able to deliver retirement savings at the low annual cost of 0.3% of the fund. Both the NAPF and the ABI have taken issue with this estimate. It ignores the cost of setting up the scheme and the expenses employers will have to incur to comply with the proposed contribution collection regime. Previous Government projects of a similar nature (such as creating the NHS database) have not run to time or budget.
A key aspect of the NPSS proposals is that regulated advice costs, which are a significant burden for existing schemes, are avoided.
It seems likely that these responsibilities cannot be completely dispensed with, but the White Paper suggests they will be met indirectly by the Government (that is, taxpayers) rather than being incurred directly by the scheme. This obviously makes the NPSS seem cheap relative to private sector provision, but is not comparing like with like.
The government also prefers a central clearing house because it will minimise the administrative burden on employers by taking the responsibility for selecting providers from their hands and avoiding the need to pay contributions to multiple funds. They suggest two models:
❑ the Pensions Commission's proposal, where the only choices are the employee's decision to remain in the scheme and select an investment fund; and
❑ an alternative, where the employee can also select the provider of the investment fund.
There will be further consultation into the most appropriate design and administration mechanisms for the NPSS later in the year, which will include ways of using private sector expertise in delivery.
The White Paper's proposals are a step towards providing a more stable foundation on which people can build their retirement saving, although a lot of detail, particularly around the delivery of NPSS, has been left to further consultation. However, it seems likely that most existing, occupational provision can continue without employers having to incur significant additional costs complying with the new system in relation to those who are already members of their schemes.
The minimum level of contribution required by the NPSS, together with the reforms to state pension also proposed in the White Paper (but not discussed here) are only likely to provide adequate retirement incomes for those on low incomes. Anyone paid more will need to make additional retirement savings if they are to maintain their standard of living in retirement and the delivery mechanism for the NPSS seems likely to leave a lot of room for continued occupational and other private saving.
Deborah Cooper is principal with Mercer Human Resource Consulting firstname.lastname@example.org