Compulsory Pension Contributions – Financial Adviser
by Dr. Ros Altmann
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The Government wants more people to put more money into pensions. We have had reviews, Green Papers, policy initiatives and consultations galore but, so far, nothing has worked. Our strong voluntary retirement savings culture is being eroded.
By 2040, the number of people over State Pension Age is forecast to rise by 40%, but Government still apparently expects to be spending only 5-6% of GDP on pensions by then. We already have an extremely low level of state pensions by most international comparisons, and this is set to fall significantly further. Policymakers are relying on private savings to offset the reduction in pensioner incomes.
Sadly, the trends are not encouraging. Stakeholder pensions have not reached their target take-up figures and company provision is moving away from final salary – accompanied by a dramatic fall in contributions.
The saviour – say many in the financial services industry – must be compulsion. The ‘c’ word is often being used and the Government has set up a task force to look at this issue. Much as I understand why many people believe this is the answer – I am not convinced.
There are several reasons why further compulsion (we already have compulsory pension savings through National Insurance, of course) will not, and should not, be introduced. First of all compulsion would probably be viewed as a tax. Secondly, who should be compelled? The easiest route, politically, would be to compel employers to contribute, rather than compelling employees themselves. This has several problems. Employers may simply adjust pay packages to offset the pension contributions. And what happens about the self employed? Thirdly, what level of contribution should be required? If a low level (say 5% of earnings) is mandated, this will be nowhere near enough to provide a decent pension, yet people will think they are contributing enough and do not need to worry any more about their pensions. There would then be a rude awakening when they retire. Fourthly, low paid workers may need all the income they receive just to survive and forcing them to put money into a pension may cause severe hardship. Indeed, there is evidence from countries such as Australia, which has compulsion, that individuals are taking on extra debt, to replace the income they have to put into their pensions, and the overall savings rate in the economy may be falling. This suggests compulsion may not be of great benefit in the long run.
I do not believe we should move down the draconian route of compulsion, before giving the voluntary savings system a proper chance. We have certainly not done this yet. We should encourage and reward people who provide for their own future, rather than force them to do so.
I would go further than this, though. Compulsion would actually be dangerous in the current policy environment. For many people, pensions are not suitable and they should not put money in them at all.
Why are pensions unsuitable? Firstly, there are significant problems with our system of means tested benefits. The Pension Credit, in my view, actually undermines pensions. It is being promoted as a policy which ensures ‘it always pays to save’, but it is being mis-sold. If financial providers introduced a product like this, they would be hauled up in front of the FSA and asked to pay compensation to people who were led to believe they would benefit from their pension savings, but find that they don’t. Government is not explaining the risks. Anyone without a full basic state pension (BSP) – most women and many men – will still lose pension income pound for pound. Just as an example, a woman with £15 per week less than the full BSP could find pension savings of nearly £20,000 would be totally wasted under the Pension Credit. (If she had saved this money in an ISA, or spent it before retirement, she would have had the benefit of it, but in a pension it is all lost.)
In fact, at best, the Pension Credit still means people lose 40% of their pension income. Given forecasts suggesting that over 70% of pensioners will be entitled to pension credit in future, it is hard to see how financial advisers can safely recommend basic rate taxpayers to put money into pensions at the moment. The requirement to lock money away for years, without access to it, and being forced to buy an annuity at the end, plus the likelihood of losing 40% of the pension, suggests that advisers should treat pensions with great care. Compulsory pension contributions in this environment are, surely, inconceivable.
Even if this huge disincentive is overcome, the Government has not introduced new incentives to encourage pension take-up. Policy has focused on giving people cheaper, simpler products and helping them to make ‘informed choices’ with decision trees and so on. However, this looks only at the supply side of pensions. It ignores the demand side – i.e. how can we make people want to engage in the pensions process? In other words, policy has not incentivised pensions enough yet. The main incentive offered is tax relief – this is not an overly enticing proposition. Again, for high net worth individuals, the incentive is quite good, (although it has fallen markedly as tax rates have declined) but for the mass market, this is not so. The UK spends about £17billion a year on pensions tax relief, yet the incentive to ordinary savers is not really enough. For every £3 a basic rate taxpayer puts into their pension, the Government adds 85p – hardly a huge bonus. However, for higher rate taxpayers, every £3 contributed to their pension gets an extra £2 from the Exchequer. This starts to look much more attractive as a ‘reward’ for locking money away.
Perhaps the Government should consider giving everyone the equivalent of higher rate tax relief – i.e. matching payments of £2 for every £3 contributed to a pension. This would make the economics of pensions much more attractive for the middle market.
Another proposal, aimed at improving demand for pensions, is to introduce a lottery attached to stakeholder pensions. For every £10 a person contributes to their pension, they will be entered into a ‘draw’ to win £1million each week (along the lines of premium bonds, but with the benefits of pension tax relief and investment accrual). This type of approach, offering a tangible reward to people today for putting money away for the future, may start to engage the interest of younger people at last. The cost of such a policy initiative would be £50million a year, which is very low compared with advertising budgets to promote pensions. Other types of reward could be considered, but it is important to understand the need to offer people proper incentives, which they can understand and relate to, rather than the opacity and relative complexity of tax relief.
If the disincentives of means testing can be removed and meaningful incentives put in place, the voluntary savings system in the UK would stand a much better chance of flourishing in the future. Compulsion is unlikely to be the saviour of savings in the UK.