The National Pensions Savings Scheme which was proposed by the 2005 Pensions Commission Report has the potential to make it impossible for millions of people in the UK workforce to ever be able to make meaningful long-term savings plans in existing products such as pensions and ISAs. This will be the case irrespective of whether or not the take-up for the new scheme, if it is ever introduced, is high enough for the Government to claim it as being successful.

A strong statement, I know, but let me tell you why I’m sure it’s the right assessment. Partly because I want you to know what I think, but also partly so that we can demonstrate one day that we said these things in the days before we all embarked on a potentially disastrous enterprise.

The proposed National Pension Savings Scheme (NPSS) would lead to compulsory pension contributions from any employer whose employees (or employee) choose to remain opted-in to the scheme. The idea is that all employees who are not covered by ‘high quality pension schemes’ would be automatically enrolled in the national scheme at some point in the future (probably in 2010). This is likely to be around 12 million people who, by and large will be working for smaller employers. People staying in the scheme, and thereby accepting the 4% of band-earnings cost of doing so, would trigger off a compulsory 3% of band earnings contribution by their employer and a 1% of band earnings top-up by the taxman. The NPSS would look like a 4% money-purchase contribution by employees matched by a 4% compulsory additional contribution made jointly by the employer and Her Majesty’s Revenue & Customs.

The NPSS, with this curious idea of compulsion only applying to people who choose it, is envisaged as being structured like existing occupational money-purchase schemes and it’s thought that it would not be regulated by the Financial Services Authority. That would clearly minimise the costs of distribution and the need for anyone involved to check on the suitability of pension saving for the individuals swept into the scheme. Because of the assumed suitability of membership and the lack of regulation involved the costs could be kept low and are proposed to be at a level no higher than an annual management charge of 0.3% (one fifth of the initial cost of running low-cost Stakeholder pensions).

The authors of the report claim that such a bold move (of introducing the NPSS alongside existing pension schemes) would drive down the costs of pension provision and spread pension coverage at the same time. Many agree with that assessment and the Government is currently working to produce a White Paper to be published in May 2006 to put the NPSS (with a start date of 2010) onto the statute books later in the year. As it is to be a White Paper rather than a Green Paper it seems unlikely that there will be any consultation on the topic. It will be done and dusted before we know it.

It looks likely that the NPSS will exist one day. Imagine, for a moment, that it came into existence yesterday (I know it didn’t, but humour me a bit and go along with it).

Because the NPSS suddenly popped-up yesterday anyone who today is a basic rate taxpayer [I’m assuming my reading of the report is correct and higher-rate tax relief would not be available under the NPSS] and already contributing more than 4% of band earnings to a personal or stakeholder pension, but is getting no contribution from their employer, would be seriously stupid if they did not immediately close their existing personal pension and redirect their savings into the NPSS instead. By doing that they’d get an extra 4% contribution and lower charges to boot. It would be a no-brainer. Any adviser who wanted to stay on the right side of things would have to recommend that basic rate taxpayer clients in this position should close their existing savings and move to the state-run NPSS. It would almost certainly be ‘best advice’.

I would say that, overnight, all people in that position would transfer to the NPSS. Those who chose not to do so would pose a considerable threat to any company or individual who remained responsible for advising them on an ongoing basis in the future. It seems unlikely to me that anybody would want to be responsible for advising such people ever again on financial matters.

Basic rate taxpayers currently saving in a personal or stakeholder pension at a rate lower than 4% of band earnings would pose a different problem to advisers and pension providers. They would need to be monitored carefully so that they could be advised to close their existing pension arrangements at any time in the future if they were ever to increase their savings to 4% of band earnings or more. It seems unlikely that long-term profitable business could be conducted with people on such a basis and that would clearly be a problem for everyone involved. It would certainly act against any further basic rate taxpayers being advised to start pension contributions below the level of 4% of band earnings.

In effect, the existing individual pension markets for people who were basic rate taxpayers would cease to exist overnight with most transferring to the NPSS and those choosing not to being shunned by advisers and pension providers.

The effect on those basic rate taxpayers with pension savings, but no employer contribution, would be immediate and dramatic. But what of the 10 to 12 million people with no pension savings that the Pensions Commission are setting out to help? The advent of the NPSS would give them an immediate issue to come to terms with; would they want to commit 4% of their band earnings (after tax) to the NPSS, or would they prefer to opt-out of the scheme and leave their take-home pay as it is?

For someone on average earnings with, say, band earnings of £21,000, the pension contribution they would be in for if they stay enrolled in the NPSS would be £655 a year. That’s the post-tax pay cut they’d have to take to trigger off the 3% contribution from their employer. The employer’s compulsory contribution would be £630 a year.

In real life, various things will happen to the unpensioned millions in this group:

1. Some people will think that something like £655 is a lot of money to give up out of their take-home pay and will decide to opt-out of the NPSS as a result.
2. Some employers may think that something like £630 is a lot of money to be compelled to pay out and may try to persuade their employees to leave the NPSS.
3. Of that group of employers, a sub-set may offer their employees additional money (but less than £630) to leave the NPSS.
4. Some people will stay in the NPSS, happy to be contributing only, say, £655 a year, but getting £1,680 paid towards their pension in total.
5. Some older people (a 56 year-old woman for example) may work out (or have it pointed out to them) that pension contributions of only £1,680 a year at their age may be a complete waste of time and that there are far more suitable things they could do with their money.

In the UK today there are more than 2 million companies ¹. Only around 74,000 of these have more than 50 employees ². The vast majority of employers in the UK employ fewer than 50 people. The chip shop near where I live has five employees, whereas the company I work for, Royal London, has something like 2,900 employees. The average company in the UK is more like my local chip shop than the company I work for.

In the real-life world of the average employer and employee relationship in the UK in the 21^st Century the five ways people will divide up the day after the NPSS comes into being will be determined by the 12 million people without pensions probably making decisions that suit both them and their employers. The Pensions Commission think that the vast majority of people will see themselves in my category 4. I don’t think real life is like that. But it doesn’t matter who is right and who is wrong. 12 million people will make their individual decisions to leave the NPSS or to stay in it. Whatever decision they make one thing is for sure; they will never again be likely to save in other long-term savings products such as stakeholder pensions or ISAs.

The five groups I have outlined will effectively come down to just two broad groups:

1. those who stay in the NPSS, and
2. those who decide to opt-out of the NPSS

Those who stay in the NPSS will most likely feel that 4% of their earnings will be enough to be salting away, but if they want to add further savings would almost certainly be advised to do so within the low-cost environment of the scheme. It is highly unlikely that they would ever make private pension savings outside of the NPSS while they remain basic rate taxpayers unless an artificial cap is placed on NPSS contributions.

Those who decide to opt-out of the NPSS would effectively become ‘advised opt-outs’. They would be giving up the compulsory pension contribution of their employer as they would have been automatically enrolled in the NPSS and could only get out again by opting-out. This would make them very much like the nurses or mineworkers who did not join, or left, their occupational pension schemes in the late 1980s. Companies and advisers who subsequently sold long-term savings products such as personal pensions to such ‘opt-outs’ were wrong to do so. The advent of the NPSS will precipitate millions of personal decisions that could leave millions of people in the UK workforce as ‘opt-outs’; people who financial services companies and advisers wouldn’t touch with a bargepole.

So it doesn’t matter in the end what decision basic rate taxpayers make with regard to NPSS membership as far as the financial services industry and advisers will be concerned; either way they will be off-limits to us.

So if the NPSS is launched, it will all come down to one big bet from the Government. They will be gambling that it is worth throwing away the voluntary, advised long-term savings markets in the hope that 80% of the workforce will jump on the NPSS bandwagon. That’d be a very big bet!

The advent of the NPSS will either mean that basic rate taxpayers will benefit from the low costs of pension saving in the NPSS or will become financial lepers as far as the financial services industry is concerned. If all 12 million with no provision join the NPSS that will be a good result for the Government, although it would immediately cost a fortune in tax-reliefs, but that would be balanced in the very long term by a big decrease in means-tested handouts to pensioners. On the other hand, if hardly anyone joins the NPSS it will be a bit of a disaster for the Government as the long-term costs of means-testing would surely rise if people found themselves totally excluded from saving in other long-term savings products, although in the short term they wouldn’t have to shell out billions in tax relief.

It’s a swings and roundabouts thing I guess, but anything in between total success or total failure will be such a muddle, with no-one knowing who could save in financial products and who couldn’t, that it could be seen as nothing other than an enormous step backwards for the country that used to be the envy of Europe with it’s well-funded voluntary pension system. The confusion and complications currently surrounding pensions would seem as nothing compared to the complete dog’s breakfast we could end up with by 2010.