Beware of personal accounts – reconsider before it’s too late
by Dr. Ros Altmann
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The Government has announced a delay to its flagship reform of private pension savings will be delayed which will now not be fully implemented before 2016 – beyond the next Parliament. This gives an ideal excuse to rethink the whole scheme. The policy should be halted, not delayed, because personal accounts, as currently designed, could actually damage private pensions for many workers, rather than improve them.
The plan is to automatically enrol every worker who does not already have access to a ‘qualifying’ employer pension scheme into a national scheme of personal pension accounts. Workers will have to contribute 4% of salary into the scheme, with their employers putting in 3%. The laudable aim is to broaden pension coverage and improve lower earners’ pensions. So far, so good, but unfortunately the current pension environment is not conducive to this system.
There are many reasons to be concerned about personal accounts. A nationally organised, low cost private pension scheme has theoretical attractions, but it also puts the Government at risk of being held responsible in future for people wasting their savings.
As things stand, it has far more potential to make pension provision worse, rather than better. For a start, the 3% minimum employer contribution has now given employers the target of cutting back to the 3% minimum and some are already cutting contributions in advance, so people currently in employer schemes may end up with less pension once the lower employer contribution is taken into account.
In addition, many individuals will be automatically enrolled who should not be in pensions at all. Pensions are unsuitable for many people, but there is no independent advice built in to help people understand the risks and complexities they face. Generic advice cannot possibly address this adequately.
Why is the policy going ahead despite its potential pitfalls? Well perhaps part of the reason is that personal accounts do offer excellent opportunities to large interest groups, especially in the early years, whereas the threats posed will be faced by individuals over the longer term. These large interest groups all stand to benefit in the first few years of personal accounts – which must go some way towards explaining the ‘consensus’ in favour of the scheme.
The groups who stand to gain short-term advantage are politicians, who can claim that they have solved our pension problems by getting millions of people saving in a pension; the Treasury, which sees an opportunity to save benefit costs later as many people will actually just be saving to replace means tested benefits in future; financial companies, who will earn fees on managing the personal accounts (even if they are low fees, they still amount to attractive revenue streams); and also there are opportunities for employers to cut their current pension contributions – which average over 7% in defined contribution schemes at the moment – down towards 3%. Employers are being tempted with a nationally organised scheme that will allow them to cut their pension costs substantially – and also avoid the need to organise their own arrangements for their staff. Hardly a surprise, then, that the CBI has welcomed personal accounts.
Unfortunately, personal accounts also entail significant risks. But these risks mainly threaten ordinary, unsuspecting workers, not big interest groups, so they are not being sufficiently recognised or taken seriously. The risks include the danger that workers currently in an employer pension scheme with an employer putting in more than 3% could end up with less pension if their employer switches to personal accounts or cuts contributions. Also, lower earners who will be entitled to means tested state benefits on retirement may lose all their personal accounts pension later and have wasted their money. There is no plan to ensure people receive independent advice to help them assess the suitability of personal accounts – and we all know that generic advice cannot possibly address the risks and complexities of this decision.
There are other issues too. The Federation of Small Businesses is opposed to the policy as small employers will have a significant extra administrative burden and even if their workers do not want to be in the personal accounts at all, the employer has to auto-enrol all their staff in and then the staff themselves have to opt out. Every time workers join a new employer, they will have to be put into the scheme automatically. Only then can they opt out, by presumably signing a form to say they do not want to have the money taken out of their salary and put into a pension. This could well mean that the administration of the personal accounts scheme will be a nightmare – tracking millions of tiny pots of money over many decades from people who were automatically enrolled and forgot to opt out straight away.
As an example, under the personal accounts, if workers put in 4%, their employers will have to put in 3% of ‘band earnings’ (between around £5,000 and £33,500 a year) so younger workers earning, say, £20,000 a year will have around £50 a month deducted from their salary, with employers adding around £37.50 and tax relief about £12.50. Those who forget to opt out immediately cannot get this money back. Even just one month’s money has to stay in the personal account for decades and has to be administered and invested until the workers reach retirement.
In addition to all this, it seems that no serious consideration has been given to how people will get good pensions out of personal accounts – having a fund is not enough, it has to be turned into retirement income.
Unfortunately, today’s politicians are only worried about people putting money in, whereas what matters is that workers get good pensions out. But worsening annuity rates mean the current forecasts of pension outcomes are far too optimistic. Most workers cannot expect to get much pension from their personal accounts, but they will probably not find that out until much later. The official studies so far do not address this issue properly at all. The official investment and annuity assumptions do not stand up to scrutiny and it is not clear that lifetime annuities make sense for all.
Of course, today’s politicians and financial company directors who benefit from management fees in the early years will be long gone before workers realise the inadequacy of their personal account pensions.
To make personal accounts work, we need radical reform of the state pension first, with an end to mass means-testing of pensioners. Even after all the recent reforms, nearly half of future pensioners will be on means-testing. This makes private pension saving unsuitable. ISAs may be a better product for many – especially those who are young, with large debts or who have not yet bought their own home.
Personal accounts will automatically enrol millions of workers, many of whom should not be in pensions at all, due to the interaction with state pension means testing. The idea of the state choosing investment products and forcing employers to contribute to workers’ pensions that might merely replace benefits later is not sensible. We need to redesign state pensions so that there is a decent basic minimum provided by the state – perhaps from a later age, making pensions suitable for everyone.
The personal account reforms are an appealing idea in theory, but in practice they are a disaster in the making. Phasing them in more slowly does not improve the outcome, it will merely prolong and complicate the agony. Instead of delaying implementation, far better to address the problems that are already obvious in its design, before even more time and money are wasted on a policy that has the potential to make pension provision worse, rather than better in future.