This month’s Off the Record considers the question of compulsion. Should people be obliged to make additional provision for their retirement, on top of what they pay in taxes for a state pension?
The matter of compulsion is fundamental in pension provision. The rationale for making second pillar contributions compulsory is that it prevents moral hazard. Without compulsion, it is argued, people will not save enough voluntarily for their old age, and may become a burden on society when they grow old. In countries that have adopted structural reforms, mandatory retirement savings pillars have been adopted as part of the mandatory scheme in order to keep the PAYG tax-and-transfer system small.
In some European countries, membership of second pillar occupational pension scheme is not mandatory. In 1986 the UK gave employees the choice of opting out of the second tier of its public pension system and buying either defined contribution or defined benefit plans in the private sector.
Two thirds of UK employees opted out, but not all of them contributed to private pensions. As a result, a large proportion of the population have no pension coverage other than their state pension, which will no longer provide a decent income in retirement.
Furthermore, UK employers are not obliged to contribute to the new contributory company pension plans – known as stakeholder plans - which the government has introduced to encourage people to supplement their state pension.
The labour unions in the UK, represented by the TUC, want to introduce compulsory employer contributions across the board. They believe this would restore confidence in occupational pensions, and make stakeholder schemes more attractive to the people who are most likely to be without cover.
The employers, represented by the CBI, reject the idea of forcing them to pay. Such a move, they say would increase their costs and threaten the viability of small firms.
The UK government appears to agree and has rejected compulsion in its recent pension reform proposals. Is it right to do so? We wanted your views. As ever, there is a wide range of opinion, although on balance the pension fund managers and administrators who responded to our survey preferred compulsion to choice. A clear majority (62%) agree employees in general should be obliged to participate in second pillar, occupational pension arrangements.
Among those who disagree are some who feel that it depends on what other incentives there are to save. The manager of a Dutch pension fund points out that “a lot depends on what other long term facilities the government can offer – for example saving for one’s own home.”
Others feel that although compulsion is unacceptable, people should be guaranteed a decent level of income at retirement. One UK manager says: “Individuals should be up to a level sufficient for a minimum retirement income. If they are too poor, they should be subsidised.”
There is strong support (70%) for the suggestion that employers should be obliged to provide pension plans for their employees. There are some caveats, however. The manager of a German pension fund suggests that employers should be obliged to provide plans that are funded by the employee.
There are also worries about the ability off small companies to provide pension plans without government help. One UK pension fund manager says: “There should perhaps be a government or government-sponsored agency scheme for small employers.”
If employers provide contributory pension plans, should employers be obliged to contribute to them? A majority of respondents (62%) think they should. There is less agreement about what the level of contribution should be.
What do you think the ratio between employer and employee contribution should be? A slight majority (54%) feel that the employer should contribute twice as much as the employee, while a substantial minority (42%) say that employers and employees should make equal contributions.
For some, the ratio is less important than the size of the contribution. A Swedish pension manager comments: “Any ratio would do as long as the employee makes a contribution that is not insignificant,” while a Danish pension administrator points out that “The ratio doesn’t really matter since most employees will look at it as part of their salary.”
Should compulsion to contribute to a supplementary be extended to the self-employed? A small majority (57%) think it should. Many are not so sure. A Dutch pension fund manager says compulsion should be eschewed “unless it is a political issue to prevent people from gaining easy access to social welfare”.
The prickly issue of pensions holidays and reduced employer contributions draws a mixed response. A clear majority (68%) think that a company should be allowed to vary or reduce its contribution to a company pension plan. Again there are caveats. It would need trustee approval, a UK pension fund manager says. A reduction should be allowed “only in exceptional circumstance and after negotiations with the social partners,” according to a Swedish pension fund manager. A company should not be allowed to reduce contributions unilaterally, “and certainly not in a DC scheme,” says a Dutch pension fund manager.
There is less support for contributions holidays. A narrow majority (54%) think that companies should be allowed to take contributions holidays. One suggests: “There should be a minimum contribution that is always payable unless the scheme has a mega surplus – perhaps liabilities twice covered. Any contribution holiday should be reviewable annually rather than just at a triennial.” Many feel that contributions holidays are risky in these volatile times. “Retirement is a long term obligation and as we have seen lately things may change quickly.”
One of the arguments against compelling employers to contribute to employees’ pension arrangements will increase costs for employers and threaten the viability of small businesses. This cuts little ice with the majority (63%) of our respondents. One points out that “costs should be built in to business plans. Another says that “any employer should take into account reasonable level of costs.”
The argument against compelling people to save for a pension is that it reduces their wages, with the net effect of too much saving and not enough income. Again, this proposition gets little support. A substantial majority (89%) disagree. disagreed. One manager observes that “a remuneration package is a balance of current and deferred pay. Maybe employees should be given more choice in how they balance those.” The administrator of a Danish pension fund argues: “In the long run saving for a pension does definitely increase life income.”
Opponents of compulsion suggest that better tax incentives are a more effective way of encouraging employers and employees to participate in pension arrangements. This wins strong support, with a substantial majority agreeing (83%). Yet many warn tax incentives , by themselves, will not solve the solve the problem.
Perhaps the problem is a lack of disposable income. Perhaps people are failing to save for retirement not because of lack of prudence but because they cannot afford to do so. This suggestion get short shrift from respondents. A clear majority (77%) disagree. “Most people are aware that it is common sense to save, but at the same time they tend to be able to persuade themselves into believing that they cannot afford to,” a Danish pension fund manager dryly observes. A UK pension fund manager suggest that “in many cases it is due to a lack of prudence, ie, the wrong priorities.”
Yet a clear majority (67%) agree that most people, acting on their own, will never be able to save enough to provide for an adequate retirement income. One UK pension fund manager says this is an argument for compulsory employer contributions. “Employer contributions effectively force employees to make some provision for retirement.”
However, there is some fundamental disagreement with the idea that people, by themselves, can never save enough for a proper pension. One UK manager says: “It may be true for the poorest 30% or 40%. But if it were true generally it would also be a fact that firms and the state would not be able to save enough either. It is ‘most people’ who pay taxes and contributions that pay pensions.”
A Dutch pension fund manager has the simplest suggestion for people who want an adequate retirement pension. “Start saving at birth”. So now you know.