The fundamental flaw in the Government’s grand plan
by Dr. Ros Altmann
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There has been plenty of positive comment about the new name for personal accounts – the NESTs. These pension savings accounts, funded jointly by workers and their employers, are supposed to ensure that future retirees will have a good private pension to supplement the meagre state pension. The whole project, however, seems to me to be misguided and is in danger of misleading millions of workers into believing their future is taken care of, when in fact they may find that their NEST is empty on retirement. There are significant cracks in the system.
What matters to today’s politicians and financial providers is to ensure that people are putting money into a pension fund. They will then respectively be able to claim that future pensioners will have good incomes from their savings, and earn fees on the money being managed. But this is missing some essential points. Firstly, if the investment vehicles do not perform well, expected returns will not materialise in the way workers are being led to expect. Secondly, workers may find that their NEST merely reduces the means tested benefits they would otherwise have received on retirement. Thirdly, what happens if annuity rates on retirement are very different from today?
This issue of annuity rates has been completely ignored so far. The studies carried out, to supposedly demonstrate that low to moderate earners should benefit from their NEST, fail to consider the impact of annuity rate changes on the eventual pension received. Indeed, there has been exclusive focus on the pension fund (i.e. the pot of money building up over the years) but no focus on the actual pension (i.e. the income workers will receive when they retire). This is a fundamental flaw in the system.
In the last twenty years, annuity rates have changed dramatically and there is no guarantee that they will not continue to worsen in future. For example, in 1990, a worker aged 65 with a £20,000 pension fund, could have bought a single life level pension of £60 a week. However, in 2000, that same £20,000 pension fund would only buy a pension of £35 a week. And in 2009, the pension would have fallen to just £25 a week. So, even if the investment returns had delivered the expected size of pension fund on retirement, the amount of pension that fund will buy could be far less than anticipated, thus undermining the value of the NEST for delivering future security to workers.
It is entirely possible that annuity rates will keep falling in future, especially if Solvency II is introduced as planned and annuity providers have to rely on gilts, rather than a mixture of gilts and corporate bonds. Also, as more defined benefit pension schemes seek to de-risk, they may increasingly buy bulk annuities and this, together with increasing defined contribution provision, will take up more of the limited annuity volume and lead to pressure on pricing.
In my view, the Government needs to think far more carefully and creatively about the pension outcomes from NESTs and improve the security of pension amounts delivered by workers’ contributions. It could offer guaranteed annuity rates, or issue pension gilts that helped deliver interest and inflation protection over the long term. It could issue mortality bonds too. However, at the moment, it is simply ignoring the problem perhaps because it will only materialise over the longer term and today’s politicians will no longer be around to have to deal with any disappointed workers who find their NEST-eggs have not delivered.