UK: Good pensions now – please!
Adrian Waddingham, founding partner of consulting actuaries Barnett Waddingham, sets out his pension priorities for the new government
It is 20 years since governments (unintentionally) started to undo good British pensions. Our ‘new kind of government' is ideally placed to re-invigorate retirement saving. Last week's decision - widely anticipated - to abolish the default retirement age next year will make much more sense if it is combined with a new impetus to help as many employees as possible afford a good retirement. It is right that those willing and able should be able to choose to stay at work, but it will be good for both employers and employees to ensure that people do not become trapped in their jobs.
From about 1963 up to the end of the eighties about half of all those employed in the UK benefited from membership of good workplace pension plans - usually traditional final salary schemes. Things started to go wrong in the 1980s, when a combination of regulation, improving longevity, stock markets falls, low interest rates and the imposition of compulsory extra benefits made traditional plans unaffordable. Participation in DB plans in the private sector fell significantly in the 1990s. The assumption has been that only defined contribution (DC) schemes are now viable, but this does not suit lower-paid employees who lost most by the decline in workplace pensions. Some say that DC better suits a mobile population. However there is little evidence to suggest that people change jobs more frequently than in the seventies, and pensions for those leaving DB plans before retirement are now well protected.
The new pensions minister, Steve Webb, has highlighted the need to develop a strong state pension as the foundation for workplace saving. How right he is. Even at their best workplace pensions only reached half the workforce. The basic pension is both too complicated and inadequate. Government should start planning now for a better, simpler benefit. The new commitment to increase state pensions in line with inflation, average earnings, or at least 2.5% pa is a welcome first step.
The next steps should be to increase the basic state pension over the shortest possible timescale to bring the level in line with the pensions credit threshold, and so reduce the number of pensioners claiming means-tested benefits. We should also combine the basic pension with the state second pension (S2P). Secondly we ought to review the national insurance contributory principle with a view to introducing in the longer term a citizens pension based on residency. These changes can be paid for by increasing the state pension age incrementally to age 70 between 2020 and 2030. This seems a fair price to pay for better benefits. Further changes to state pension age should be linked to life expectancy, subject always to at least 10 years' notice.
We need a simpler system for private pension provision that people can understand. We should close the savings gap and encourage people to accept responsibility for making financial provision for retirement. The role of the state is to provide a platform, and a barrier against absolute poverty in old age with much less means testing. We need a flexible tax system that encourages pension saving and does not discriminate between different types of contributors. We should support employers who are able and willing to provide good quality pensions for their employees and cut back on the regulations and tax disincentives that discourage them from doing so. The legislative changes to allow new plans, which would share the risks of inflation, investment and longevity between employee and employer will not be difficult.
Workplace pensions at their best overcame the natural apathy against retirement saving, and at reasonable expense. The last government was never convinced that good workplace pensions could come back, but that was never a reason not to try. Traditional schemes will not come back as they were: they became far too expensive. But it would not be difficult to design new, affordable schemes. For example, a total of 15% earnings would normally cover a career average scheme offering benefits on a one-hundredth basis. But finance directors need more than a scheme that is affordable now: after all, once bitten twice shy. Good employers need to be reassured that new schemes can adjust to changing circumstances. If longevity improvements continue apace they will need the safety valve of retirement age adjustments, and retrospectively. The state allows itself (prudently) to raise state pension ages respectively albeit usually with ten years notice. Employers should be allowed to do the same.
We can also facilitate more innovative pension scheme design by relaxing the rules on price indexation, and other of non-essential regulation which attaches itself to DB schemes. The government is itself a major employer, and freeing up the design of pensions will help government as much as companies in the private sector.
Recent legislation has set the scene for good protection of pensions, yet hardly any new schemes are being established. The Pensions Regulator has already raised standards on the funding of defined benefits, and the Pension Protection Fund is there to help the few schemes falling into difficulty. The governance of workplace schemes is better than ever. We should use all this good stuff to encourage good pensions.
Doubtless, the new government will confirm the introduction of auto-enrolment into existing pension schemes from 2012, but I suspect it will review the arrangements for NEST. Now does not seem the best time to add to costs, and a further pause will give good opportunity to consider better, less risky alternatives for the lower paid.
Finances are not easy, and government rightly keeps the tax incentives for pensions under review. A new system of pensions might well need tighter rules on tax relief. Perhaps companies starting new schemes should only have their pension contributions allowed for tax relief if the new scheme is open to all employees on the same terms. Furthermore, a cap on tax relief might be appropriate. Government is already thinking of limiting personal pension contributions to about £40,000, and limiting relief to 40%. There is a danger that too-strict limits on pensions for the decision makers will mean that they are less keen to provide pensions for others.
Finally I would like to see a new permanent Pensions and Retirement Commission to determine pensions policies, and with an explicit brief to encourage wider pension provision. The agenda must plan for positive change, and with the longer term planning so important for pensions.
Adrian Waddingham is a founding partner of Barnett Waddingham in Amersham and London