Empty NESTs and cracked eggs
by Dr. Ros Altmann
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The Government’s pension NEST-egg plans have huge cracks
The new workplace pension savings accounts could be a disaster for millions of unsuspecting individuals
The project should be halted before more money is wasted
- Policymakers are ignoring the risks of NESTs
- The dangers of future means testing are being swept under the carpet
- The likelihood of employers cutting contributions back to 3% is not taken seriously
- The problems of worsening annuity rates have been totally ignored in all the forecasts of future pension outcomes, but future regulatory changes could be very damaging
- The risks of poor investment returns are not being taken seriously enough
- Pensions for lower and middle earners are about retirement security, not just maximising investment returns
- Workers will be lulled into a false sense of security and many will lose much or all their pension in means tested state payments
- NESTs are continuing because they offer short term benefits to powerful vested interest groups, who care little about future dangers for unsuspecting workers
Politicians will claim credit for getting more people to save in a pension
Employers will cut costs by cutting pension contributions back to 3% minimum
Treasury will save money on future means-tested benefits
Financial companies will earn fees on managing the money each year
- The risks fall on the workers and future taxpayers who have no voice at the moment
- When the Government promotes the NESTs will it be honest about the risks?
- I don’t think so!!
Changing the name does not change the nature: Changing the name of ‘personal accounts’ to ‘NESTs’ will not make them work any better. Indeed, by ploughing ahead with this project, regardless of the risks to the lower and middle earners they are aimed at, the Government is continuing to ignore the dangers of forcing workers into a pension arrangement that may not be suitable for them.
Lower earners need the security of their future pension, and should not be taking investment risks with that security: Pensions for lower and middle earners are not really about maximising investment returns. They are about providing security for their old age. The state pension does provide adequate security (we have about the lowest state pension in the developed world), so individuals are expected to try to do this for themselves, perhaps with an employer’s help. But if the state pension system means-tests half of pensioners, then the lower and middle earners cannot safely save in a pension, for fear of losing much or all their future income.
Means testing penalties are being ignored: The Government has acknowledged this issue exists, but has pretended it does not matter.
Investment and annuity risks are serious threats to future pension outcomes: In addition, the Government has failed to focus sufficiently on the investment risks workers will face. It has also ignored the risks of future changes in annuity rates.
Levelling down is a huge threat, but employers are keeping quiet about it: Finally, policymakers have failed to grasp the scale of cutbacks in existing pension coverage that the NESTs will engender. Employers are currently contributing well over the 3% minimum, but they will have a huge incentive to cut back to much lower levels once the Government’s scheme starts. This means workers with pensions at the moment could end up worse off in future.
Why is this project still going ahead? Why is there so much apparent support?
Large vested interest groups will benefit near term: The answer is that there are too many powerful vested interests who stand to benefit in the nearer term from proceeding with this policy initiative, while the risks will fall on others who do not have a voice, for whom the dangers will only become obvious in the longer term. The groups who benefit are as follows:
Politicians, who can claim they have ensure millions of workers are saving in a pension
The Treasury, which will watch workers saving to replace means tested benefits later
Large employers, who have spotted the opportunity to cut back contributions to 3%
Financial companies, who will earn good fees on managing workers’ money each year
What really matters to the workers is the pension they get out, but what really matters to the politicians, employers and financial industry is how much money is being put in!
Risks borne by the workers being automatically enrolled will emerge longer term: The risks will be borne by trusting workers who are automatically enrolled into a NEST without realising they should not be. These people could discover, but not for many years, that their NEST merely replaced the means tested state benefits they would otherwise have received. Future pensioners are at risk of receiving very little from their contributions. A worker earning £20,000 a year will be putting £50 a month into their NEST, and will assume that this means his or her future security is taken care of. But 8% of band earnings will not deliver much pension without great investment returns which are not guaranteed and who knows what annuity rates will be in the future?
Employers will cut back towards the minimum, so pension outcomes will be worse for many: Many workers also face the danger that employers will cut their pension contributions back to the NEST minimum (which is less than half of current average employer pension contributions). This levelling down effect is already starting, as the Government has given employers a new target to aim at – as long as they are putting in 3% that’s all they need to do. The failure of policymakers and the pensions industry to take this danger seriously is deeply depressing. We are watching pensions disintegrate, amid claims of hugely improving the situation! Hardly a surprise, then, that the CBI supports it, while Federation of Small Business does not.
Wasting public money on flawed project: If we do not abandon this project soon, we will waste even more money on a pension savings scheme that is not fit for purpose. There will also be administration problems with tracking tiny pots of money for workers who forgot to opt out in time and whose money is locked away for decades by the pension system.
Promotion of nests will not be honest about the risks – if it was, people would not sign up! When the Government promotes the NESTs, will it be honest about the risks? Will it own up to the risks of means-testing penalties in the state pension? Will it explain to workers that their future pension is at the mercy of future annuity rates which could be far lower than todays? Will it use reasonable projections to explain the true risks of equity investment and the fact that workers could end up with less than they put in if their risky investments do not perform as expected?
If the Government is honest about the risks, most younger people will be put off. If the Government, however, is not honest about the risks then future taxpayers may end up funding compensation claims from workers who explain how the Government misled them about the value and security of their pension savings.
We need a proper radical overhaul of the state pension system, to provide a basic, non means-tested residents’ pension: The reality is that we need a proper radical overhaul of our pension system, not piecemeal reforms that force people to save in an unsuitable system. We must start with reforming the state pension – it should pay a decent basic minimum, as of right, to all citizens without mass means-testing. Once we have made it safe for people to save, it should be up to them to negotiate whatever help they can get from their employer to help fund long-term savings for their future. There is no certainty about long-term investment, there is no magic that can transform small contributions into big pensions. It can happen, but it may not. People have to understand the uncertainty and the risks and then they may have to save far more, or plan to work longer, in order to fund the lifestyle they might want in later life.
Pensions are about two things – about future security and about long-term investment returns. The two are not the same. As long as the state does not take care of future security without damaging saving incentives, we will not have a system where it is safe to save and lock money away in a pension. We should allow early access to the money, perhaps with penalties and should improve the flexibility and honesty with which long term savings are provided.
NESTs cannot be relied upon to deliver good pensions. The Government has embarked on a very dangerous project which will prove damaging to many in future. We should leave it to individuals, employers and the financial industry to choose what combination of extra saving or working they can assume for later life. There are no guarantees beyond a minimum social safety net, but if that safety net undermines private saving the system cannot work properly. The sooner we rethink both pensions and retirement, the better.
Dr. Ros Altmann
8th January 2010