DWP latest paper on pension reform does not go far enough
Reinvigorating retirement saving is about more than pensions
Defined Ambition needs to define a different ambition – capital sum more attractive than income
by Dr. Ros Altmann
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The DWP has today put out its ideas for reinvigorating pensions. There are several interesting suggestions but the paper may have missed some important areas which could form a fundamental part of ensuring more people save more money for their future.
Policy should think carefully about the needs of those saving.
Reform State Pension Improve Suitability: Firstly, without reform of state pensions, to eliminate mass means testing, many workers cannot safely save in a pension. ISA saving is safer for them.
Inflexibility Of Pensions: Secondly, many younger workers may need to pay back debts and save for a house, but policy is designed so that only saving in the most inflexible way counts for the employer contribution. Pensions force people to lock money away for decades, which means they cannot touch it even if they desperately need it. That understandably puts people off contributing in the first place.
Guarantees Won’t Give Good Pensions Without Big Contributions: Thirdly, the idea of guarantees has been tried many times and failed to provide sustainably good pensions. If all a guarantee does is ensure a return of contributions then why would pensions be so attractive? Guarantees are expensive and can only ensure relatively modest pensions. Large contributions are required to generate good pensions.
Defined Ambition Should Define A Different Ambition – Capital Sum Rather Than Income: The UK has a very different system from many other countries in that our pension system tries to ensure a pension income rather than a pension fund capital sum. The provision of a lifelong income has proved too onerous and risky for employers and has undermined confidence in pensions as annuity rates have plunged. The worsening of annuity values makes most people’s pension funds deliver paltry pensions and undermines the attractiveness of pension products. Most workers would feel much better about being promised tens of thousands of pounds as a capital sum in later life, that a few pounds a week in pension income.
If we really want to reinvigorate retirement saving then we need to rethink the way we think about pensions!
What Would A Better System Look Like?
- Improve pension flexibility: Currently retirement saving is considered to be about just one product – which is the most inflexible. Money is taken from workers in younger life and they cannot touch it till later life. Then most people have to buy a totally inflexible annuity to provide an income. If people were allowed access to their own pension contributions if they really need the money, the system would ensure that pension saving was safer and more suitable for many younger workers with debts and no home of their own. Many should save their own money in an ISA while leaving the employer contribution and tax relief locked in till later life. At the moment, when it comes to incentives for retirement saving, policy says it’s ‘pensions or nothing’ so many people get nothing because they can’t cope with the inflexibility.
- Remove annuity requirement: people should not be encouraged to buy a level annuity at the start of their retirement. This offers no protection against inflation and, as annuity rates have plunged, people get poor value. Annuities are also a completely inflexible product.
- Target a capital sum rather than income: it is time to rethink pensions. They need an image makeover and part of that could include aiming for a sum of money, as happens in most other countries including the US or Australia, rather than aiming for income. This would sound much more attractive to the average employee. This suggests Defined Ambition should be about cash balance plans. Employers cannot be relied on to stay around for 60 or more years to keep paying pension incomes in retirement.
- Use ‘SMART’ approach to increasing contributions – Save More Tomorrow: If workers are encouraged to put part of their pay rises into extra pension contributions, rather than reducing current pay, it would be much easier to encourage extra contributions. This works with psychology, and if combined with more flexibility would encourage more contributions, rather than trying to force people to part with money into a very inflexible and uncertain product.
The bottom line is that Reinvigorating Pensions is about more than just one product. A ‘star rating’ system for pensions will still focus on the current product and approach, but flexibility and suitability are also vital issues to be considered. This discussion should be about finding better ways to increase the attraction of saving for later life, which means changing the inflexibility of pensions, reforming the state pension and talking about capital sums rather than incomes. This consultation should be re-titled ‘Reinvigorating Retirement Saving’.
Dr. Ros Altmann