New UK Government Initiative: Security in Retirement
June 30, 2006
On 25 May 2006, the UK Government published its new initiative (the White Paper) on pensions entitled “Security in retirement: towards a new pensions system”. The White Paper follows on from the Second Report of the Pensions Commission which was published on 30 November 2005 and sets out the UK Government’s main proposals for the future of the UK pensions system. This is against a backdrop of longer life expectancy, changing expectations and attitudes towards working life and retirement, and falling birth rates. Dramatic changes in the private pensions system, which include the decline of defined benefit structures and the switch to defined contribution structures, the failure of stakeholder pension plans (an earlier Government initiative), and growing apathy amongst the population generally towards saving for retirement have also influenced the initiative.
Key Proposals
To promote private pension saving, from 2012 all employees will automatically be enrolled into personal savings accounts into which:
- Employees will contribute 4 per cent of earnings of between £5,000 and £33,000 a year
- Employers will contribute 3 per cent (although employer contributions will be phased in over a three-year period at a rate of 1 per cent a year, so that the employer contribution rate will initially be sent at 1 per cent, increasing to 2 per cent in 2013 and to 3 percent in 2014)
- A further 1 per cent will be added in the form of basic tax relief on individuals’ contributions
Employees may opt out of these personal savings accounts (if they do, no employer contributions will be payable). However, in an attempt to combat inertia and to reflect potential changes in an employee’s financial position, opt-outs will be revisited on a regular basis (at least every three years) unless they are expressly renewed by the employee.
Where an employer already offers its employees a pension plan which meets certain minimum criteria, employees will not need to be automatically enrolled into these personal savings accounts. These criteria are yet to be determined but are likely to include contributions of at least 3 per cent, automatic enrolment, target benefit levels and/or low costs.
The details of how these personal savings accounts will be provided and managed are still to be decided, and further proposals are expected later this year. However, various parties have made suggestions. The Association of British Insurers (ABI), unsurprisingly, prefer that insurance companies provide these personal savings accounts. The National Association of Pension Funds suggest the establishment of “master trusts” to provide these accounts, while the Government favours a centralised fund. According to the Government, with the economies of scale, the fact that there would be no requirement to market a single state-operated provider and the fact that it would be unlikely to be required to incur the costs of providing regulated advice, a centralised fund could be operated at a cost of 0.3 per cent of fund value per annum.
State pension provisions will also change:
- The state pension age will increase to 66 from 2024, 67 from 2034 and 68 from 2044 (each increase will be phased in over a two-year period).
- The basic state pension will once again be linked to earnings rather than prices. This link may be restored by 2012 “subject to affordability” but could be delayed until the end of the next Parliament which could be as late as 2015.
- From 2010, the number of years required to qualify for the full basic state pension will be reduced to 30 from 44 for men and 39 for women.
- The second state pension will become a flat-rate weekly payment by 2030.
- Contracting out for defined contribution arrangements will be abolished (at the same time when the basic state pension is to be linked back to earnings).
There will be additional changes to the current pension credit system and related issues.
Comments
These proposals are now subject to public consultation during the next 15 weeks. There is still considerable detail to be discussed, particularly with regard to the operation of the new personal savings accounts. We also expect further consultation on the impact of the introduction of personal savings accounts on smaller businesses.
The UK Government wants to encourage people to save, and this is obviously welcomed. A national pensions saving scheme set up by way of personal savings accounts which employees are opted into by default could go a long way towards assisting those who are currently discouraged from joining pension arrangements to save for their retirement.
However, the introduction of the personal savings accounts will likely impose greater financial and administrative burdens on small businesses. The British Chamber of Commerce (BCC) has warned that the compulsory employer contribution to the new personal savings accounts may force small employers to cut back other costs, for example, salary increases, investment or staffing levels.
A 2005 BCC pensions survey found that 74 per cent of small employers did not provide an employer contribution to pension arrangements because it was cost prohibitive. A requirement to do so runs the risk of making British business less competitive in the world market. On the other hand, the manufacturers’ organisation, the EEF, has been very positive in particular in relation to the introduction of compulsory personal savings accounts. The Institute of Directors (IOD) welcomed the majority of the changes while opposing compulsory employer contributions. Arguably, the timescale for implementation of these personal savings accounts and the staggered introduction of contributions may give employers time to adjust their remuneration strategies to comply with the new requirements.
The extent to which the Government will put in place additional transitional arrangements and support to smaller employers remains to be seen. Larger employers should be less affected as they are more likely to have alternative pension arrangements in place already.
The ABI recently questioned whether the reforms should also be made applicable to self-employed individuals. This group constitutes one-eighth of the UK workforce, yet they represent approximately one-quarter of all UK non-savers.
We would also question the true significance of the 1 per cent contribution received through the tax rebate—this is no more than is currently given to contributing members of registered pension plans under the existing system.
It also remains to be seen how the new state pension age of 68 can be reconciled with the age discrimination legislation. Currently the “default” retirement age is 65, and from 1 October 2006 an employer cannot force an employee to retire before that age (unless this can be objectively justified). Presumably, over time, this “default” age may have to be raised to mirror the new state pension age, which will in turn pose further challenges for employers in implementing employment practices.
The Department for Work and Pensions (DWP) has also recently issued a press release stating that it is seeking to secure consensus with the Opposition parties in relation to pension reform. The Minister for Pensions Reform stated on 14 June 2006 that this is “a policy with a fifty year horizon” and that “the public expect us to create a stable framework within which they can invest”. While the proposed reforms seek to create such a stable framework, to what extent the proposed reforms will be carried through in their current form and remain in force over the next 50 years remains to be seen.
