Response to Pension Commission First Report – Ros Altmann

    Ros is a leading authority on both private and state pensions,annuities and
    retirement policy. Numerous major awards have recognised her work to
    demystify finance and make pensions work better for people.

  • Ros Altmann

    Ros Altmann

    Response to Pension Commission First Report

    Response to Pension Commission First Report

    Response to Pension Commission First Report

    by Dr. Ros Altmann

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    I just wanted to
    give you some of my thoughts on Pension Reform, by way of response
    to the Pension Commission report. I found the analysis in your
    report excellent, thorough and well-presented and was very impressed
    with the subjects covered. My response focuses on the issues
    relating to compulsory pension saving, although, of course, issues
    such as the movement away from traditional defined benefit pension
    provision are likely to prove some of the most intractable pension
    problems we face. I have not addressed these here, but would be
    happy to talk to you about these. My main points are:

    1. I do not believe there really is a ‘muddle through’ option.
    2. Radical state pension reform is urgent, abandoning mass means
    3. Phasing out contracting out could pay for a resident’s pension
    for all.
    4. Compulsion is not an answer.
    5. Better and fairer incentives are required, both for individuals
    and employers.
    6. Pensions, alone, cannot finance an ageing population. We need to
    re-think retirement.

    1. There is no ‘muddle through’ option.

    I do not really believe there is a muddle through option. We cannot
    keep going as we are. The current policy mix is unsustainable going
    forward and radical changes are urgently required. In the absence of
    radical reform of the state pension system, it is impossible to see
    how private pensions can improve.

    2. Radical state pension reform is urgent, abandoning mass means

    It is urgent for the state system to be re-designed, to overcome the
    disincentive effects of means testing, which will increasingly
    continue to undermine private pensions. If 75% of future pensioners
    will have to claim pension credit, then it becomes impossible for
    financial advisers to safely advise the majority of the population
    to contribute to a pension. It is not true to say that pension
    credit ‘rewards’ saving, it penalises saving. It may penalise saving
    by less than the previous system (‘only’ 40% penalty rather than
    100%), but many individuals, especially women who do not have a full
    basic state pension, still lose £ for £ and find their whole pension
    savings have been wasted. Such mixed messages are very dangerous for
    private pension sustainability. Furthermore, from a practical point
    of view, it is difficult to see how the DWP can be expected to
    reliably deliver the administrative systems which will correctly
    oversee the means test and pay the right benefits to so many
    millions of people. The costs and risks of trying to do this,
    coupled with the imperfect take-up, means that pension credit will
    not necessarily succeed in reducing the numbers of older people in
    poverty in future. Even if take-up rises to 90%, there will still be
    over 1 million pensioners in poverty in future. With 15 million
    people over age 65 by 2030, of whom 75% will be eligible for pension
    credit, if 10% of these do not take up their entitlements, this
    leaves 1,125,000 people in poverty. So after all the cost, expense,
    complication and risk of undermining private savings, which are
    associated with the pension credit policy, the policy will still
    leave a huge problem of poverty in the UK. Radical reform of state
    pensions is a necessary condition for improving private savings, but
    is not a sufficient condition. The current complicated state pension
    system, with its over-reliance on means-testing, and lack of
    clarity, is undermining private pensions.

    3. Phasing out contracting out could pay for a resident’s pension
    for all.

    One of the most complex parts of the UK state system is contracting
    out and it is often not delivering pensions at a high enough level
    to replace state earnings related entitlements. The cost of
    contracting out is huge – £11billion a year – and this money has
    operated as a subsidy to private pension providers, but not
    delivered good value to individuals in terms of adequate pensions.
    This money could more usefully be diverted to current pensioners, to
    finance payment of a resident’s pension for all, at the level of the
    pension credit guarantee credit (currently £105 per week). This
    would provide a clear division between what the state will pay as a
    pension – a basic minimum – and what individuals can then freely do
    for themselves on top of this, without penalty from the Government.
    It is not clear to me that the state should be providing earnings
    related pensions at all. Just because someone earned more when they
    were working, why does that mean that the state should give them
    extra when they are no longer working? Surely, those who have higher
    earnings can afford to save more for themselves. I would be in
    favour of just a flat rate state pension, paid at a basic minimum
    level to allow people to escape poverty. This would then allow
    financial companies and advisers to give a clear message to people.
    ‘This is what you will get from the state – it is enough to live on,
    just, but if you want more, you will need to do some saving on your
    own to be able to afford life’s luxuries. Whatever savings you do
    make, will be yours, with no penalty from the State.’ This clear
    message cannot be given at the moment, because no-one knows what
    people will actually get from the state pension system and also
    cannot be sure that they will not be penalised by the pension credit
    if they do save.

    4. Compulsion is not an answer

    On the question of compulsion, it is not clear to me that there is
    any evidence that this really works in terms of increasing the
    overall level of savings. There are a several potential drawbacks to
    compulsory pension saving. Firstly, it is not clear that compulsion
    actually delivers higher overall savings levels. In other countries
    where compulsory pension contributions have been introduced, savings
    seem to have been diverted from other sources into pensions.
    Secondly, many lower paid individuals take on extra debt, to make up
    for the loss of income which is being diverted to pensions. Thirdly,
    there is doubt about the level at which compulsion should be
    pitched. If it is pitched too low (perhaps around 5-10% of salary)
    then it will not deliver good pensions, if it is pitched at a more
    adequate level (around 20% of salary) then this will be too high a
    level to be politically acceptable. Fourthly, compulsory pension
    saving would be have a negative impact on economic activity, as
    Australia found when workers suddenly diverted substantial amounts
    of their income away from consumption and into saving. Of course, if
    a higher level of state pension is paid, as of right, the need for
    compulsion will be minimised, since the consequences of inadequate
    pension saving will not result in higher state spending on means
    tested benefits. Having said this, however, it is clear that it
    would be preferable for individuals to decide to save, if they can
    possibly manage to do so, in order that they can enjoy a higher
    standard of living than the basic state-provided minimum in later
    life. This would be better for consumption and economic growth, as
    the population ages. Auto-enrolment and schemes which divert future
    pay rises into a pension, rather than sacrificing current income,
    are likely to be far preferable to compulsion. It would still then
    be an individual’s choice as to whether to put money into a pension,
    rather than being compelled to do so. Finally, in the current
    environment, compulsion should not be considered at all, because
    pension credit has made pensions an unsuitable investment for a
    large proportion of the population. If they risk be penalised by at
    least 40%, then they may be better off saving in a different form.
    So reform of the state system is essential before compulsion could
    be safely considered – but then once a radical reform of state
    pensions has been introduced, of course, compulsion would no longer
    be so necessary.

    5. Fairer and better incentives are required, for employers and

    Fairer and better incentives to save are required. Given the
    extremely low levels of confidence in long term savings, I believe
    that the Government needs to introduce better incentives for both
    employers and individuals to contribute to pensions. The current
    system of tax relief is unfair, regressive, opaque and inefficient,
    as a means to encouraging those on basic rate tax to contribute to
    pensions. The highest incentives are going to people who need them
    the least and those who find it hardest to save are not receiving
    enough encouragement. A system of matching incentives would be far
    better than the current tax relief system. People would understand
    it, there could be the same level of incentive for the same level of
    contributions and the costs could be controlled by changing the
    annual limits on contributions.

    6. Pensions, alone, cannot solve the problems of financing an
    ageing population. We need to re-think retirement.

    We have to recognise that, in truth, at least 80% of the population
    can probably never be expected to save enough during what we
    currently consider to be a ‘normal’ working lifetime, to provide
    what would be considered an ‘adequate’ level of pension income for
    the current idea of a ‘normal’ period of retirement. I believe that
    only the top 10-20% of earners can truly put enough money aside for
    30 – 35 years of work to provide a good income level to live on for
    25-30 years of retirement. However, the opportunities for a social
    revolution in attitudes to work offers a possible win-win solution.
    I think there is a whole new phase of life out there, waiting to be
    grasped, which previous generations could not even dream of. The
    period after full time work, when people are still working, but part
    time, either in the same job or a different line of work, but still
    earning money and contributing to both their own and the wider
    public economic welfare. Why are we paying so many people not to
    work? Why should people who are fit, healthy and mentally alert – as
    most people in their 60’s and even 70’s now are – expect to sit at
    home without working? This is a huge waste of resources. We need a
    social revolution, whereby employers make work available to older
    people on a part time, job sharing or mentoring basis and
    individuals plan during their lifetime for what they would like to
    do, once they stop full time work. This would mean that pensions
    need to last for much less time and also need to be at a lower
    level, to supplement earnings, rather than replace them. This could
    be a realistic solution to the problems associated with an ageing
    population, both in terms of overcoming labour shortages and making
    the financing of older populations more affordable. Such a social
    revolution has been achieved for women in the past few decades – the
    majority of young women, even with young children, now work. Thirty
    years ago people would have said that this could not happen, but it
    has. I can envisage the same changes occurring for older people, who
    will be able to continue working well into their 70’s, at least on a
    part time basis and then have far more income to live on and enjoy
    their extra leisure time with. This is a positive message. Pensions
    alone can provide decent incomes for 5 or 10 years (which was their
    original intention) but not for 20 or 30 years. It is not healthy
    for individuals to suddenly stop working at any particular age and a
    flexible band of gradual retirement would be much better for the
    individual and for society as a whole.

    This represents a summary of my views on pension reform, as relates
    to the issues surrounding compulsion. On a wider note, I do believe
    that the issues surrounding the movement away from traditional final
    salary scheme coverage are important and the investment of pension
    scheme assets needs careful attention. I do not believe that merely
    moving from an over-reliance on equity investments, to an
    over-reliance on fixed income investments, is necessarily optimal.
    In order to manage a liability-focussed asset allocation, it is
    important to recognise that fixed income investing cannot match
    defined benefit pension liabilities perfectly and bonds still
    contain downside risks. In fact, I would argue that moving away from
    over-reliance on equities and reducing the risk of relying on just
    one source of investment risk premium, should be done in a way that
    minimises the loss of expected return. This would not be achieved by
    switching into bonds. A more diversified asset allocation, trying to
    capture returns from a wider range of asset classes and taking
    advantage of uncorrelated assets or different potential sources of
    alpha and beta, would deliver a more efficient long term portfolio.
    I would be delighted to discuss these issues, if you wish.

    I do hope these thoughts will prove helpful to you in your work.

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