The future-proofing of pensions - a way out of the pensions impasse
It seems to me that whatever industry meeting I go to these days we always end up speaking about the same things. It boils down to this; the best way to reach the currently unpensioned is through the workplace and the employer; the means-test acts to make pensions unsuitable for many; blanket advice on pensions is therefore not possible; so pensions can’t be spread to those who need them. At which point people start suggesting that the whole environment needs changing and we need to scrap the means-test and increase the basic pension etc. etc. Well yes, but that’s not going to happen overnight, and it’d be a massive climbdown for the Government, and how likely’s that? I think it’s time for us to be a bit more pragmatic and accept that where we are is where we’re going to have to start from whether we like it or not. I also think we could make some easy-to-do changes to the new Pensions Bill that’s being written at the moment that would kick-start pension savings again and make it possible for employers and professional advisers to give blanket advice to groups without anyone losing out or risking sanction by the regulators. The following text is the draft of a pamphlet I will be speaking to and distributing at the political party conferences this week and next. I’m publishing it here first, because I want regular BeeLiners to be the first to see it. I hope you will see what we’re getting at and agree with our suggested solution. Anyway, here it is.....
We are where we are. Today in the UK, it is far more likely that existing defined-benefit occupational pension schemes will be closed by employers, than that new schemes of any type will be established by employers who have not thus far provided pensions for their employees. At the same time, individuals who could choose to save independently for their own pensions appear to be less likely to do so than has been the case in the recent past. This for a number of loosely-related reasons. For employers, at least, it stems in part from the steep increase in the costs of pension provision coupled with a move towards annual accounting for the liabilities they are responsible for over the longer term. For individuals there is an apparent lack of trust in pension providers and needlessly complex products, as well as the general perception of bad value for money offered by pension investments due to recent stockmarket conditions and changes in expected longevity and the consequential effect that has on the level of annuity provided. This has led to general and widespread concern regarding the state of the voluntary pensions saving markets in the longer term, against the backdrop reality of a State Pension system that is designed to produce ever lower benefits in real terms over the next forty years. The low value of the State Pension even today has itself led to a dramatic increase in the need for means-tested benefits for existing pensioners to alleviate poverty in retirement.
Yet, overall, the voluntary pensions saving system we have in the UK has, by European standards at least, been an outstanding success over the last four decades. The UK currently has more pension monies invested than the total of the funded pension arrangements of the whole of the rest of Europe combined. The past successes of the voluntary system, though, have not been uniform in nature, and have in fact allowed a highly-polarised position to arise in the UK as far as pension provision is concerned. As things stand, half of those in the current workforce are covered by good occupational pension schemes, whereas the other half are not.
The Government has been right to tackle this inequitable position and has identified that the best (and most economic) way to achieve more widespread pension coverage, particularly among those on modest earnings, is most likely to be through engaging the help of employers. While it is true that half of those in the workforce are members of occupational pension schemes, far fewer than half of all employers provide them. It is the larger employers that tend to do so, and the smaller employers who do not. There are far more smaller employers than there are larger employers.
The Stakeholder pensions initiative was put in place to tackle the joint problems of under-provision and lack of trust and, in some respects at least, has been successful. Overall, however, the launch of Stakeholder pensions has not so far proved to be the catalyst for widespread change that the Government had hoped for. It is the view of those of us within the Royal London Group, however, that a further simple improvement to the Stakeholder pension regime is all that is needed to enable us to move out of the current impasse and for the Government’s objectives to be met.
Recent actions by Government have put the onus on all but the very smallest employers to make pensions available to their employees in the workplace. This has resulted in over 300,000 new pension schemes being put in place in the UK in the last two years. While this unprecedented increase in the number of pension schemes is an undoubted success, it is an unfortunate fact that, two years on, the vast majority of those schemes still have no members in them. And that, of course, cannot be regarded as anything other than a failure of the Government’s policy to spread pension scheme membership more widely.
In our view, and in our experience of dealing day to day with professional distributors of pension products, the root cause of this problem lies with the fact that the means-test, which is so necessary for the good of existing pensioners, is acting as a disincentive for tomorrow’s savers. The Pension Credit, which is soon to be introduced, is designed to alleviate this problem, but in our view it does not do so. This is because those who are unfortunate enough to have to rely on the means-test face a higher marginal rate of withdrawal than they receive in tax-relief as they save. Indeed, we are of the opinion the introduction of the Pension Credit only serves to make matters worse by spreading the problem to more people, with the end result being that, for many in today’s workforce, other products than pensions may be more suitable investments for those wishing to save for the future. This is an unfortunate and unintended consequence of the well-intentioned wish to provide for those who have already retired.
For employers and professional pension distributors, the fact that pensions are not intrinsically suitable investments for all, means that blanket advice cannot be given to groups of people (an employer’s workforce for example), and that the only alternative is to distribute pensions to people one at a time rather than to groups of people as a whole. The economics of this, coupled with the constraints inherent in the capped Stakeholder Pension product, mitigates against any realistic opportunity for more widespread pension coverage.
Because of this, many are asking for a so-called “safe harbour” for employers and other professional pension distributors, so that they are not held responsible for distributing unsuitable pension savings products to some people while at the same time they introduce suitable pensions to others. While such an approach would be effective in breaking the current deadlock and would make pension distribution to groups of employees possible once more, it is not an approach we agree with. It cannot be right that unsuitable products should be distributed to people in any circumstances. In our view, at least, not even for ‘the greater good’. We suggest a more pragmatic approach is considered as a way out of the current pensions impasse.
Royal London suggests that changes should be implemented in the next round of legislative change (expected to go through in the current Parliamentary session) to allow pension holders the right to have their money back, less a tax charge, if at State Pension Age it can be demonstrated that they would have been better off not to have saved with a pension. Such a right would effectively give people the feeling that they would have a good deal more control over their pension savings, something we would suggest they do not feel at present.
There is a precedent for allowing disinvestment of pension savings where they are only likely to produce trivial retirement benefits. The recent consultative document from the Inland Revenue recommended that the existing definition of triviality should be increased to allow people with total pension funds of less than £10,000 to be returned as a lump sum instead of being converted to an annuity. This is a welcome extension of the existing principle, and is one that we think could be built on to enable all those whose pension savings act against their best interests in the future to undo their savings plans if they wish to do so. In this way, people would have control over their pension products in the future, rather than their products having control over them as has been the case in the past.
Such a change in emphasis in the nature of the pension product itself would allow us to reap the full benefits of the recent introduction of the Stakeholder Pension and the proposed changes to make our pensions legislation simpler and easier to understand. It would mean that joining a pension scheme could not ever again turn out to be an uneconomic financial decision for anybody. With what we regard as the major impediment of potential unsuitability removed, pension distribution would thus be freed up in a way that would be consistent with the Government’s wish to extend pension savings to the less well off. In short, employers and their advisers would be able to stand up in front of groups of employees and recommend that they join the pension arrangements the company has put in place. Something they are simply unable to do at the moment.
We suggest it as a pragmatic way forward from where we are. Perhaps one day we will find we are in a better position with regard to universal State benefits and with less reliance on means-testing, but we are concerned today that long-term solutions to the current pensions impasse could come too late to stop the rot that has set in to our pensions system. Our suggestion that this session’s legislation should be used to introduce ‘future-proofing’ to UK pensions would, we think, still stand the test of time even if we do eventually find ourselves in a more Utopian pensions environment one day.
A future where better levels of basic pension are granted to everybody as a right and taxed back from those we as a society agree do not need it, seems preferable to us to where we are today with State pension benefits payable on the basis of contributions made, but leaving millions with insufficient assets at retirement to claim means-tested support. Not least, it would mean that pension saving would be inherently suitable for all. But if that, or any similarly efficient and fair system is where we eventually end up, it is our view that the future-proofing guarantee that we are suggesting here would still be valid; people would simply have no need to exercise the option of disinvestment. The fact it was there, though, in these days, would mean more people would have been able to save for a pension in the first place and we will have had the continued advantage of a healthy pensions market in the meantime. Future-proofing is a pragmatic approach to the pensions impasse we currently find ourselves in. We see it as a way forward, not an end in itself.
30 September 2003
This document is based on Scottish Life’s understanding of current tax law and the Inland Revenue’s proposals and the Pensions Green Paper issued on 17 December 2002. These proposals are subject to consultation and may change in the future.