UK: A pension coalition
The UK's new coalition government was as quick to tackle the tricky issue of pensions policy as it was surprisingly quick in its formation. Gill Wadsworth outlines the issues under consideration
The UK's coalition government has got off to a flying start on pensions since coming to power in May this year. In spite of the uncertainty and the complications of power sharing, the Conservative and Liberal Democrat administration has grasped one of the hottest political potatoes and embarked on a series of reviews and reforms that will alter the face of nation's retirement provision irrevocably.
Large swathes of the government's potential pension policy will prove unpopular with the electorate, unions, employers and some sectors of the industry, but for many commentators bold action is required irrespective of its wider appeal.
The immediacy with which the incoming government has tackled pensions is in large part motivated by the ongoing difficult economic conditions. Prime Minister David Cameron has made clear that reducing the £156bn (€188bn) budget deficit is the government's number one priority, which means the burden of unsustainable state and public sector pensions has to be dealt with quickly and radically.
Consequently, pension policy needs to be two-pronged: one strategy needs to allow government to reduce its role in the messy and expensive business of public pension provision, while a complementary strategy should make the private sector a more attractive place for individuals to use as a reliable source of retirement income.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: "The unifying themes are deregulation, personal responsibility and re-engagement. Investors are being presented with a pension system that encourages them to take an interest in their retirement plans, knowing that they will be treated fairly by the government and rewarded for their thrift. It is still a long way from perfect but they are off to a good start."
The government has so far pledged to continue Labour's policy of auto-enrolment which would force all employers with a workforce of 50 or more to provide a contributory workplace pension scheme for all qualifying employees. The idea is to roll the policy out from 2012 starting with larger employers and finishing with the smallest by 2016. However, critical details of this radical reform are yet to be finalised, not least the shape and structure of the National Employment Savings Trust (NEST) which will act as the default workplace scheme.
At the same time, the government has pledged to reform public sector pensions, which have been saddled with the ‘gold-plated' tag and are widely seen as both unfair and unaffordable. As final salary pension provision disappears from the private sector, its persistence for public sector workers is creating something of a problem for the government. Not only is the administration facing a multi-billion pound hole in public sector pension funding, it is also dealing with a possible mutiny from taxpayers who resent paying for benefits to which they themselves are not largely entitled.
The public sector pensions commission, headed by Labour MP and former work and pensions secretary John Hutton, has a number of options open to it: reduce benefits, raise the retirement age, increase contributions and move to a risk-sharing or career average structure.
"I would like to see proper transparency about the costs of public sector pensions, as well as exploration of the options for reform," says Ros Altmann, independent pension consultant. "In particular, a consideration of increasing member contributions and ending contracting out of the state second pension; this alone would make a significant difference to the cost of public sector pensions."
Under normal circumstances dealing with public sector pensions would be more than enough for one government to attempt but given the need for drastic cost-saving measures, the coalition also plans to increase state pension age by one year. From 2016 men will need to have reached age 66 before they can claim the basic state pension and for women the same will apply from 2020.
In keeping with the two-pronged approach to pensions reform, the government announced in July that forced retirement at age 65 in the private sector will be abolished. This gives employees the right to work indefinitely should they so desire, and has been widely welcomed by pension commentators.
"We live in an increasingly ageing society and coupled with the economic environment of recent years it is not realistic to force people to retire at a certain age; many of us will have to work longer to ensure we have a comfortable retirement," says Ian Naismith, head of pensions market development at the insurer Scottish Widows. "By scrapping the default retirement age, it gives employees the flexibility to retire when they want to rather than being forced to end work prematurely."
The government's pension reform has also extended to the ‘at retirement' market and in an effort to make pensions more attractive to savers, the forced purchase of annuities at age 75 has been scrapped. This has proved a hugely popular move since many providers and advisers felt that compulsory annuities made the market inflexible and had the potential to develop into a mis-selling scandal.
"Many people are put off saving in pensions because they don't understand how pensions work and resent the inflexibility when they want to take benefits," comments Patrick Connolly, head of communications at independent financial adviser AWD Chase de Vere. "The government seems to be addressing both of these concerns and this is a further encouraging sign that they want to simplify rules and make pensions more flexible."
Given that the private sector is set to be the primary source of retirement funding, the government will have to do everything possible to make pensions an appealing destination for savers' hard-earned cash. Tax efficiency has always been pensions' most enticing characteristic, but this had come under attack from the previous administration, which had looked to abolish the higher rate tax relief for those earning over £130,000.
The move had proved deeply unpopular and was seen as corrosive not just for higher earners but for the entire notion of pensions saving. Consequently, a return to the status quo proved an easy option for the incoming government to curry favour with the pensions industry, even if it means missing out on potential tax revenue.
Julie Patterson, director of authorised funds and tax at the Investment Management Association, comments: "Simplification of pensions tax relief is welcome [but] the government needs to ensure the regime is understandable, durable and achieves its purpose. Currently many savers do not understand how changes in pensions tax relief will affect them. The regime needs to allow effective planning for retirement and to encourage people to save for the future."
The government has also attempted to ease some of the cost burden for employers offering defined benefit pensions by changing the statutory minimum rates at which these benefits must rise from retail prices index (RPI) to the consumer prices index (CPI). Since CPI generally rises more slowly than RPI, this legislative change could see liabilities reduce by as much as 10% for the typical scheme over the long term.
However, how this change is to be implemented remains unclear, and Marian Elliot, head of actuarial services at the consultancy Atkin & Co, predicts trouble ahead. She says: "The change from RPI to CPI has some obvious stumbling blocks: whether this overrides existing rules; whether it applies to annuities already secured; and how it interacts with the requirement that benefits in DB schemes are not retrospectively reduced."
Maintaining the momentum and keeping the pensions industry onside are critical if the government is to finish what it has started with pensions reform. Such positive feedback from commentators is unusual and the coalition has achieved much already in securing the industry's support. However, there is a tremendous amount of ground still to cover and policies tackling the really thorny issues are still to be formulated.
Keven LeGrand, president of the Society of Pensions Consultants, concludes: "The government must adopt and articulate a clear vision, with a published plan for achieving it, and all of the specific policies then introduced must be presented in the context of that plan. This will start to rebuild confidence by showing that pensions are important and are actively encouraged by the government. If the coalition government fails to step up to the plate, a whole generation will be exposed to pensions poverty."