Response to Government pension consultation on auto-enrolment and NEST

by Dr. Ros Altmann

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1. Just getting people to contribute small amounts to a pension arrangement does not solve the problem of inadequate retirement income.
2. Automatically enrolling everyone into workplace pensions, as currently proposed and in the current UK pension system, may even lead to future litigation from pensioners who were not given adequate risk warnings about the dangers.
3. A pension may not be a suitable product for low to moderate earners, they may be better off with an ISA to avoid means-testing penalties. Increasing the trivial commutation limit could help here, but may not be sufficient.
4. Without radical reform of our state pension system, I believe it will be almost impossible to ensure private pension savings are safe for average earners. Indeed, there is also a risk of lulling workers into a false sense of security, whereby they believe their pension problems are sorted, but we know that 8% of earnings is very unlikely to deliver much pension income.
5. Pension saving cannot quickly reduce pensioner poverty, since pensions take many years to build up. From 2011, millions more pensioners will reach pension age and automatic enrolment will not address the looming pensioners crisis.
6. The best way to tackle pensioner poverty quickly, especially for women, is to pay a decent universal state pension, as of right, to all citizens. Even if that is paid from age 70, 72 or even 75, at least there will be a particular age beyond which private income will be free from means-testing penalties.
7. Perhaps the pensions vehicle could be redesigned to be more like an ISA/pension hybrid, or a lifetime savings account, so means-testing penalties can be avoided, by allowing withdrawals.
8. Auto-enrolment should not start with a ‘big bang’ approach. We should first enrol into existing pension schemes which are almost all better than the statutory minimum.
9. Auto-enrolling into existing schemes first will reduce the threat of levelling down, as current employer contributions average 6-7%, rather than the statutory proposed minimum of 1% or 3%. Starting with existing schemes will also give better information on likely levels of opt out in practice.
10. The current automatic enrolment rules are a classic example of over-regulation – exemplifying the traditional UK approach ‘if it’s pensions, it must be complicated’.
11. The rules should be relaxed by:
    • abolishing the band earnings concept
    • only auto-enrolling people with earnings above £15,000
    • allow a three-month waiting period
    • allow workers who know in advance they definitely do not want to be enrolled to chose to stay out before being put in (for example overseas workers or those with other pension arrangements)
12. The idea of NEST is good, but the risks and costs to the Exchequer and to workers of introducing it, as currently designed and into the current UK pension system are too high.
13. A 2% initial charge makes NESTs cost advantage relatively weak, at least for the coming few years. That makes NEST a less attractive proposition for all concerned.
14. Investment and annuity risks have been significantly underestimated. The Review needs to re-evaluate the ‘pays to save’ analysis. The previous conclusions ignored annuity risks but if annuity rates continue to fall, then pension income will be hit, even if investments do well. Perhaps Government should issue or underwrite annuities for NEST.

I believe this Review needs to be considered as part of an overall review of our entire pensions framework. This is an opportunity to rethink retirement saving in the context of our overall pension system, most particularly whether and how encouragement of private pension saving fits in with existing private pension provision and the present state pension system.

If the objective of current policy is – as suggested in the Review’s remit – to tackle pensioner poverty as quickly as possible, disturb existing provision as little as possible and maximise voluntary private savings while minimising administrative burdens on employers, as well as delivering value for money at low risk for the Exchequer, then the policy will fail.

The fundamental problem that requires attention is the inadequacy of our State Pension and the excessive complexity, as well as mass means-testing, which prevents our state pension from providing a clear and adequate social welfare minimum on which private savings can be safely built.

ENDS
Dr. Ros Altmann
13 August 2010

Notes for Editors:

1. The following link will take you to my full written response to the Review Team.
2. Here is just the Executive Summary of my response

Executive Summary

This Review is of critical importance to the UK’s social, economic and financial future.

I believe it needs to be considered as part of an overall review of our entire pensions framework. This is an opportunity to reconsider retirement saving in the context of our overall pension system, most particularly whether and how encouragement of private pension saving fits in with existing private pension provision and the state pension system.

If the objective of the current policy is – as suggested in the Review’s remit – to tackle pensioner poverty as quickly as possible, disturb existing provision as little as possible and maximise voluntary private savings while minimising administrative burdens on employers, as well as delivering value for money at low risk for the Exchequer, then the policy will fail.

Just getting people to contribute small amounts to a pension arrangement does not solve the problem of inadequate retirement income. And by automatically enrolling everyone into workplace pensions, the Government runs the risk of future litigation from pensioners who were not given adequate risk warnings about the dangers of our current pension system.

The fundamental problem that requires attention is the inadequacy of our State Pension and the excessive complexity, as well as mass means-testing, which prevents our state pension from providing a clear and adequate social welfare minimum on which private savings can be safely built.

A pension may not be a suitable product for low to moderate earners, since mass means-testing and pension credit could penalise their pension income in retirement.

The best way to tackle pensioner poverty quickly, especially for women, is to pay a decent universal state pension, as of right, to all citizens. Even if that is paid from age 70, 72 or even 75, at least there will be a particular age beyond which private income will be free from means-testing penalties.

Pension saving cannot quickly reduce pensioner poverty, since pensions take many years to build up. As the demographic time bomb kicks in from 2011, will millions more pensioners as the baby boom generation reaches their 60s over the next ten years or so, automatic enrolment will not address the looming pensioners crisis.

Without radical reform of our state pension system, I believe it will be almost impossible to ensure private pension savings are safe for average earners.

An alternative possibility would be to change the nature of the pension product itself, to enhance its suitability. For example, if pensions are no longer a ‘locked box’ but the pensions vehicle could be redesigned to be more like an ISA/pension hybrid, or a lifetime savings account, then means-testing penalties can be avoided. In addition, if those with big debts or who want to buy a home can spend the money in their pensions if needed, or if the state means-testing system were to ignore workplace savings income up to a certain level for the means test, again pensions would be safer to force workers into.

Reform of the proposed system of auto-enrolment is required to make it simpler and to only enrol into existing schemes first
The currently proposed system of auto-enrolment should be reformed. It places too heavy a burden on employers and is far too complex. Indeed, these automatic enrolment rules are a classic example of over-regulation. We need to focus on simplification, rather than the traditional UK pension policy approach which seems to be ‘if it’s pensions, it must be complicated’.

Auto-enrolment should not start with a ‘big bang’ approach. It would be much better to first enrol into existing pension schemes. These are almost all better than the statutory minimum.

By first enrolling into existing schemes, the dangers of levelling down would be reduced. Nearly all employers are already contributing more than the 1% or 3% statutory minimum. Average contributions into money purchase schemes are 6-7% of salary. By specifying such a low minimum, the Government has already given employers are much lower target to aim at and this runs of the risk of making pension provision for many workers worse, not better. It would be far better for the Government to have just let employers automatically enrol staff into their existing schemes, without setting its own minimum contribution level, especially one that is so much lower than existing average contributions.

In addition, enrolling into existing schemes would also give useful practical information on how many people do opt out, to be able to assess the likely impact of policy more accurately.

Reform of the auto-enrolment rules:
The concept of band earnings should be abolished. Contributions should be based on entire salary.

Only those with earnings above £15,000 should be automatically enrolled.

There should be a three month waiting period, so temporary workers and short-stayers have more chance to opt out.

If workers know in advance that they definitely do not want to be in a pension scheme, the employer should not be forced to automatically enrol them. For example, overseas workers or those with pensions elsewhere.

Should NEST go ahead?
The idea of NEST is good, but the risks and costs to the Exchequer of introducing it, as currently designed and into the current UK pension system are too high.

Investment and annuity risks have not been adequately addressed and, with a 2% initial charge, the cost advantage is relatively weak, at least for the coming few years.