Putting the genie back in the DC bottle

I like Steve Webb. He has a difficult brief as pensions minister, but he has done a good job, mainly down to the fact he knows what he’s talking about and, more importantly, he actually cares about pensions. This puts him clearly into a different bracket than the majority of his predecessors who only saw pensions minister as a stepping stone to a ‘bigger and better job’ in the Treasury. (This appears to be a Labour career path!)

And I like his optimism that company pension schemes can be saved. Or rather company pension schemes can be saved where the employer takes on some ‘guarantees’ (or promises as we must call them).

But I am not sure I completely agree with him.

Final salary schemes were great for employees. But we have to be realistic, those days have gone. The vast majority of private final salary schemes are not only closed to new members, but are rapidly shutting up shop for existing members too. And most of these companies have put a defined contribution scheme of some type in their place.

Defined contribution schemes aren't a completely free ride, they come with some employer responsibility. There’s the promise to pay the right contributions at the right rate at the right time. And there are corporate governance responsibilities, to one degree or another depending on the scheme chosen. No doubt these will increase over the next few years as automatic enrolment begins to really bite. But these are not the cripplingly financial responsibilities of the final salary scheme.

So, is there really an employer demand for the ‘defined ambition’ schemes Mr Webb is planning? These schemes aim to share the risk more evenly between employer and employee. And whilst every employee would be crying out for these, will employers really go for them? They – in all probability – already have the defined contribution scheme in place, even if just for new employees (at the moment). So, we are asking them to forget this cheaper more controllable pension, and set up something which is better for their employees, but has repercussions for their balance sheet?

Maybe this is just a way of easing the path for public sector schemes to change from defined benefit. But I would love to think that some private employers will also sign up. And I am sure there will be a few who are finally closing their defined benefit scheme to all who will. But for the rest, with the hand of automatic enrolment on our shoulder, I just can’t see them signing up to defined ambition schemes, and dispensing with the arguably cheaper and more controllable defined contribution scheme.

It will be just too difficult to put the genie back into the DC bottle.

Phew! (I think!)

After a pensions rumour mill that went into overdrive in the build-up, the 2012 Budget has been almost (whisper it) quiet for pensions. We were all on guard against a further cut in pensions tax relief down to £30,000 annual allowance, which, thankfully, didn’t materialise. To raid that particular piggy bank just at the dawn of automatic enrolment would have been a mistake. It would have just robbed employers of any lasting faith in pensions, meaning they introduce for their workers the lowest contribution rate in the safest fund possible. Meaning no-one achieves their pension hopes.

But there were some changes for pensions. After some considerable hard work, Steve Webb saw his dream of a single tier pension of £140 a week based on contributions get the official go-ahead. All we need to do now is figure out exactly how this will work in practice, and especially its interaction with contracting out. And presumably the White Paper to be published over the next few months will help us do that.

State pension age is to be reviewed automatically so that keeps pace with increases in longevity. This sounds like the thorny subject of SPA is going to be taken out of political hands and placed under a neutral watch. This is especially interesting for public-sector schemes whose retirement ages are now linked to SPA – they won’t have the government to blame, just a faceless actuarial/statistical entity. But with longevity still on the rise, it could mean that 30-somethings today are going to have to work until they are in their 70s. Not a pleasant thought.

Finally, there was also an announcement for pensioners. The age-related income tax personal allowances are to be removed and instead there will be just one personal allowance for everyone. True it will be a much more generous one, thanks to the Coalition Government’s aims to boost it up to £10,000, but the current system of age allowances really helps out moderate-income pensioners. In 2011/12, those between 65 and 75 were able to receive £2,465 more income before being taxed, and those over 75 £2,615 more income. These full age allowances however are only available to those earning less than £24,000.

These allowances will be frozen in cash terms at £10,500 and £10,660 respectively until the universal personal allowance catches up. And that action will raise a staggering total of £3.3bn of revenue for the Government over the next four years. Making it clear that moderate-earning pensioners are helping foot the tax cut bills.

Over the next couple of years, these changes could be a further blow to drawdown clients, who may see their incomes fall in their drawdown reviews because of the triple whammy of falling fund values, lower GAD limits, and revised GAD tables. Now, on top of that they will be effectively paying more tax. Consequently, they may be looking out for ways of increasing their net incomes, and that might mean transfers to investment-linked annuities to take advantage of the 120% income limit.

What can KiwiSaver teach the UK?

Automatic enrolment into pensions – due to kick off in the UK from October this year – is one huge social experiment. The sad truth is that despite spending the last eight years planning it, no-one really knows what will happen. Will employers know what to do? How many will simply ignore it? Will people stay in or opt out? How much will they save? And will it all be worth it in the long run - or will many walk away in 30 years’ time with a pittance and still have to rely on the State for the vast majority of their retirement income?

Some of these questions can be answered by looking at the economic environment. The unemployment rate, recent pay rises (if any), interest rates, the housing market. And some can be answered by looking at how automatic enrolment is being portrayed. What your employer says, what the media says, what the government says, and most important, what your mate Bill says down the pub on a Saturday night.

However, we can get an insight by looking at what has happened in other countries – and the Pensions Policy Institute (PPI) has produced an impressive paper that examines the lessons we can learn from New Zealand. NZ is one of only a few countries so far to dabble with automatic enrolment; KiwiSaver was launched in 2007.

It’s different from the UK’s version. Lower contribution rates, only one KiwiSaver per person (meaning you can carry it around with you), fixed tax relief that’s more beneficial for anyone earning below about £32,000 and a £500 one-off incentive when you take it out, and a lot more flexibility (you can get the money out in dire circumstances or first-time buyers can use it to fund their house purchase). This means it will always be difficult to do a direct comparison. But the paper draws out two important lessons on opt-out rates and contribution rates.

The opt-out rates for KiwiSaver started at 34% but dropped to 28% last year. Will the UK’s be higher or lower? On the one hand you could argue it will be lower. KiwiSaver only auto-enrols people taking on a new job and 18-year-olds. Everyone else has had to opt in. If we assume new jobholders are generally younger, then we might also assume fewer will stick with saving. Auto-enrolling everyone (as the UK will do) may gather up the 30-somethings and 40-somethings who have been in their job for several years. These people may be more likely to want a pension. Interestingly, 63% of the KiwiSaver total membership opted in – they actively chose to save – so current jobholders didn’t want to lose out.

But on the other hand, if a current jobholder is automatically enrolled they will see an immediate pay cut. And the UK version just isn’t as appealing as KiwiSaver. Less free money from the Government as an incentive, and your money is tied up for the next 40 years. So maybe the opt-out rate will be higher.

The other interesting find is the low contribution rates. Over 90% of employers are only contributing 2% (but there again they don’t receive tax relief on the contributions). If UK employers react in the same way, and just go for the bare minimum, then levelling down will be a certainty.

Individuals also tend to start contributing at the minimum level – which started at 4% but fell to 2% for new joiners after April 2009 – and stay there. Even out of those who started at 4%, only 33% have reduced to 2%, the rest have mainly stuck at 4%.

So, will all this talk of ‘get people in and then increase contributions beyond the 8% minimum’ simply fall on deaf ears? It appears so. Once they’ve made the decision to save, and at the lowest rate, it doesn’t look like there is much chance of budging them. And that makes the current discussions about ‘auto-escalation’ or ‘Save More Tomorrow’ or whatever you want to call it, even more important. We have to get people to sign up on Day One to the idea that they will (automatically) up the contribution at some later date, because otherwise they will be stuck at 8% of band earnings for ever more.

And that means the social experiment may go horribly wrong. And the chance that people will ‘walk away in 30 years’ time with a pittance’ becomes much more likely.

My top seven predictions for 2012

1.       Automatic enrolment will go ahead on time on 1 October 2012. Not that startlingly a prediction you may think, but right up to the last minute there is always the chance the Treasury will pull the plug on this initiative. Of course the bit we don’t know at the moment is the start dates for those firms with fewer than 3000 employees, and we should find that out from the DWP in the next few weeks. All we know at the moment is firms with fewer than 50 employees don’t face auto enrolment until May 2015 at the earliest. The fact the Government is willing to mess around with dates this close to lift off is ominous.

2.       The opt out rate for automatic enrolment will top 35%. And that’s if we are lucky. It could top 40% or even 50%. My biggest concern is that the Government is just not putting enough ‘welly’ behind this. It’s one thing to build a vast bureaucratic structure, forcing employers to do something, it’s a whole different thing to convince people that pension saving is ‘A Good Thing’. It may only mean giving up 1% of their salary to start off with, but that might be a step too far for many, when the upside is so uncertain. Of course, we are yet to see exactly how the DWP plan on advertising automatic enrolment, but my gut instinct is newspaper ads with lego men just ain’t going to cut it.

3.       Annuity rates will continue to fall. Don’t get me wrong. I don’t mean they will go down consistently throughout 2012 – there are bound to be upward movements as global economies (hopefully) recover. What I mean is that the overall trend continues downward driven by Solvency II, increasing longevity, and the gender directive. And with drawdown in the doldrums, there is going to be increased interest in how to get a decent income in retirement. That may mean putting off taking benefits, or considering other products such as investment-linked annuities.

4.       The date state pension age will increase to 68 will be brought forward (from 2046). With the most recent announcements it seems inconceivable that state pension age will go up to 68, 20 years after the increase to 67.  The question is whether the Government will be assured enough to make this announcement this year. After all, there’s no real rush.

5.       Open market option will get a ‘shot in the arm’. The ABI is currently consulting on changes to wake-up packs which should give the client a lot more hand-holding through the whole process, as well as highlighting the substantial benefits of shopping around. The $64m question is whether it goes far enough. And no doubt there will those who will be champing at the bit for OMO to become the default. But before that happens, we should at least be confident the vast majority will know what to do with that choice if it’s forced upon them. And at the moment, I believe, sadly, too few even understand the concept. There’s still a lot of work to do.

6.       Steve Webb will continue in his role of pensions minister for the whole of 2012. Just as long as Nick Clegg can ‘work around’ his problems, disregard his principles, and cling on to power in the coalition. It would be a breath of fresh air to have the same pensions minister for more than 18 months, so I’m hoping this prediction comes true. It’s great just having someone in charge who gives a damn.

7.       Manchester City will win the Premiership. Well, a girl has to keep the faith, doesn’t she?

Happy New Year!

The UK's senior citizens - the great unloved?

There are more of them than ever before, and the numbers are only going to swell even more in the future. And although they put so much back into society – at least £25 billion a year – a third of them believe the UK society treats them badly.

Over the past few months, I’ve been working with MGM Advantage on a report that looks into the financial and emotional well-being of the UK’s older generations. ‘Our Retirement Nation’ delved under the skin of today’s senior citizens to find out how they spent their time, what their greatest worries and regrets in life were, and how they think they fit into society today.

On the whole, I thought it made positive reading. Yes, life is tough, and lack of money and failing health are the two biggest worries. Today’s older generations don’t want to be a burden on others and they worry about how to make ends meet.

But they are generally a happy and content bunch.

The biggest number fell into the category that was able to maintain the same lifestyle in retirement, as well as treat themselves occasionally. They don’t live the high life. Instead of wining and dining they might stay in and watch telly or go – when invited – around to friends and family. But they seem to be enjoying themselves, and the freedom they have.

So, I reckon that sounds OK.

Looking at the research, there were three big areas that hit me square in the face. All of which, we – and by that I mean the financial services industry – can do something about.

1.       The first was the practice of buying an annuity was far from perfect. Almost a third hadn’t heard of the open market option (31%). Which is frightening. A fifth didn’t realise the negative impact of inflation and over a half (54%) were not aware of any way to offset it. So, imagine where they will be in 20 or 30 years’ time. And 72% didn’t know that even mild medical conditions like high blood pressure could get them a higher income through an enhanced annuity.

Obviously, we are a long way off getting this right. This part of the UK population should be more aware of the choices they face and the risks they undertake. And this responsibility falls at our feet. All of us should be doing more to educate people approaching retirement and get them to seek out the best way forward. Because they are not automatically going to wake up tomorrow saying “today I must use my open market option to buy an annuity, on the best market rates, preferably on enhanced terms. Now what’s the web address again for Money Advice Service’s annuity tables?”

2.       Secondly, the question of how to fund long-term care is being brushed under the carpet. Almost half the survey didn’t envisage having to use private wealth for that purpose – either thinking they were going to rely on the State or not even having a clue how to solve this problem. But nearly a fifth planned on using the children’s inheritance (wonder if anyone had told the kids yet?), and 26% were going to use the value of their property.

Problem is most of them have already earmarked the property as either a pension top-up plan, a children’s inheritance, or a contingency fund if it all goes horribly wrong. Or more likely all three. And that’s if they can bring themselves to sell up at all. That £100,000 equity is expected to go a long long way.

3.       Lastly, the biggest regret people had was that they had not saved enough in their working life. You can’t make a silk purse out of a sow’s ear, and the nasty truth is unless we get more people to save more money, many more will fall into the ‘restricted’ category according to MGM’s wonderful description of how the Retirement Nation is made up, rather than ‘aspiring’ or ‘comfortable’.

 

And that’s why automatic enrolment is the make or break deal it is. Delaying enrolment for all employers and putting full contributions on hold for another year is less than ideal, to say the very least. But the big question is how to keep the momentum going. To keep people talking about what’s happening and why automatic enrolment has been introduced. And – crucially - to keep them from opting out.

 

To merely rely on inertia and apathy is the wrong approach. It may get people into saving. But it won’t keep them in saving. And it won’t stop them from opting out, once somebody close whispers in their ear that they can save 3% of their wage packet. And it won’t get them saving enough money to have the kind of retirement so many both want and need.

An Autumn (Statement) Chill in the Air

“We’re not heading for a recession” asserted George Osborne this lunchtime in the Treasury’s Autumn Statement for 2011. Reassuring news? But then he proceeded to paint a miserable economic picture for the UK for the next few years, with growth barely bumping along the bottom. And that’s if the plan actually works.

Public sector workers will be (understandably) outraged that their pay – frozen for the last two years – will be capped at 1% for the next two. And although Osborne made a last-ditch plea with the unions to call off tomorrow’s strike, you got the feeling it will fall on deaf ears. The low pay outlook will only make them cling on to their incredibly generous pensions even more.

But we got a reminder of the nation’s increasing longevity with the announcement that state pension age will rise to 67 between 2026 and 2028 – eight years earlier than the plans set out in the Pensions Act 2007 – saving the UK a staggering £59bn.

This rise in state pension age was not a complete surprise. But the announcement stopped there. You could have expected the Government to also outline the increase to age 68 by 2036 (instead of the planned 2046). But as it didn’t, more cynical minds might wonder if it just wants to keep that ace up its sleeve. And play a rise to 68 earlier than 2036 at another time. Maybe it’s time we stopped second guessing when Governments will make state pension age changes, and just put it into the hands of an permanent independent pensions commission to make alterations as and when, given rising UK and world longevity.

At least with this announcement, people have 15 years to plan. This should give them enough time to put in place their retirement plans to take account of the changes. We all – government, advisers, and providers - need to do more to make sure people know when their state pension age actually is. So many people are still assuming 65. And hopefully this will be tackled as part of the automatic enrolment communications plans next year.

Elsewhere in pensions, mercifully it was fairly quiet. Despite the perennial rumours to cut the amount of tax-free cash people can take, or to reduce tax relief (further) on pension contributions, neither announcement materialised.

Enterprise Investment Schemes were given a boost and now give more tax relief than pensions, reminding us all there are various ways to invest for the future. But as their scope is limited, and many people don’t understand them, it’s likely they will continue to be a niche investment.

Finally, the Government intends to introduce retrospective legislation to curtail the amount of tax relief given on employer asset-backed pension contributions. It appears some employers have been making asset contributions to plug holes in defined-benefit pension schemes and through a loophole claiming double the tax relief. Stopping this, HM Treasury reports, will save £500m. Which makes you wonder how widespread the practice was or how big the assets were!

But we still get back £500m in the UK purse – and let’s face it, we need every penny.

To delay or not to delay . . .

With less than a week to go to the Autumn Statement, the airwaves are buzzing with rumours about the Government’s latest financial plans. Alongside the usual stories of cutting pensions’ tax-free cash, the Daily Mail today reported automatic enrolment for firms with less than 40 employees will be put back about a year.

There’s no doubt times are hard - and about to get harder – for a whole host of people in the UK, and small employers, the lifeblood of industry, must be feeling the pinch at the moment. So, I can understand why this might be seen as a Good Idea by those wishing to cut these employers some slack.

But I think, although it’s well-intentioned, it’s misguided.

Automatic enrolment is being introduced to help those millions of people who just haven’t got around to starting to save for their pensions. Survey after survey shows us that people are nervous about saving, reluctant to start, and often citing unaffordability as a reason, without thinking about the consequences of what not saving at all means for them. Automatic enrolment should be a lifeline to them. What we need to do is to educate and persuade people to kickstart the savings habit, however, unsavoury it first appears to them.

Smaller employers aren’t due to start automatic enrolment until 2014, once the bigger firms have already taken the plunge, automatically enrolled millions, and hopefully gone a step towards making saving the norm. And when they start they are being asked to contribute 1% the first year, 2% the next, and only then 3%. So softly softly to help finances.

It was hoped this approach would make the contributions more manageable.

If we really want to help these employers, then I would suggest another approach. I don’t know if you have had occasion to look at the Pension Regulator’s pages on automatic enrolment, but it’s scary! The whole thing is a minefield. Just waiting to trip you up with rules and regulations about how to deal with employees (or workers, eligible jobholders and non-eligible jobholders), and what information to send out to whom and when.

Yes, let’s make it easier for employers. And let’s start by looking again at this quagmire, while we still can, and simplify it to make it more outcome-based. Because complying with these complex, and some would argue unnecessary, rules is where the time, effort and pain of smaller employers is going to be felt. Not the 1% contribution.

Rachel Vahey

25 November 2011

@RayVay