The future of pensions

John Davies discusses the implications of the Turner report

“The UK’s pensions system is not currently in a state of crisis but this will change very soon unless people work longer or save more than they are doing at the moment.”

This is the gist of the conclusion of the long-awaited report of Lord Turner’s Pensions Commission, published on 30 November.

The report is the latest in a long line of in-depth analyses of the state of the UK pensions industry. Each of them has had some marginal impact on aspects of pensions law and regulation, but none since the Goode review which followed the Maxwell scandal in the early 1990s has received quite the same amount of attention and had quite so much expectation riding on it.

So what has Turner come up with?

First of all, he believes that the age at which we can collect our state pensions must go up. He recommends that the pension age (currently 65 for men and 60 for women, but due to be harmonised at 65 by 2020) should rise to 66 by 2030, thereafter rising periodically to reflect increases in longevity. The logic behind the idea of raising the state pension age is to reflect the fact that most people are now spending a greater part of their lives in retirement than was ever considered likely when the state pension was first introduced, and the period we spend in retirement is likely to increase still further in the future. Whereas in 1980 a 65-year-old man could look forward to 14 years in retirement, already in 2005 a man of the same age can expect to live a further 19 years.

The quid pro quo which Turner offers is that money saved by the Government could be redistributed to fund a more generous and less means-tested state pensions. He suggests that the basic state pension be retained in its current form, but more on the level of the current minimum income guarantee, and begin to rise in line with earnings from 2010 or 2011. Entitlement to it should depend not, as now, on NI contribution records but on residence - thus making the system fairer to women and carers - currently only 14% of women between 50 and 55 qualify for a full state pension and over half are not likely to qualify at all. The state second pension should also be retained but evolve in due course into a flat-rate addition to the basic state pension.

There will clearly be huge political problems for any government in telling people that they must work into their late 60s before qualifying for their state pension. The recent row over public sector pension entitlements already threatens to cast a cloud over the Government’s response to Turner. And the new rules outlawing age discrimination in the workplace, due to come into force in October 2006, while certainly being welcome in the context of pension planning, will not in themselves create jobs for that half of the population of 55 and over who are not currently in work.

Challenged

The crucial question will be “do we really need to expect people to keep working until so late in life?” (even if they can find jobs to do until their reach retirement age). The idea has already been challenged by the think tank Tomorrow’s Company in its new report, The Ageing Population, Pensions and Wealth Creation. The group argues that the UK economy should be capable of growing by a sufficient margin over the period covered by Turner to be able to keep the pension age where it is, if not to actually bring it down.

There are also significant cost implications in raising the level of the state pension and linking it to earnings. Chancellor Gordon Brown had already said that linking the state pension to earnings would be unaffordable, even before the Turner report had even been published. This view has, again, been challenged by numerous commentators. One argued that the increased costs - around £10bn in the first year and £800m per annum thereafter - can be largely offset by the savings which would accrue from abolishing means-testing and bringing down pension credits.

Turning to supplementary pensions, Turner argues that more needs to be done to encourage more people to save. Ten million of us are not saving enough for retirement, either because we have other and better things to do with our money, or because of what we believe to be high charges levied by pension funds, or because we believe that the availability of means-tested benefits will make supplementary saving pointless.

So Turner proposes a new, quasi-compulsory scheme which he calls the National Pension Saving Scheme (NPSS). This will cover similar ground to the recent stakeholder pension project, in that it will be aimed at those who do not currently have access to a company pension scheme. All employers will be required to enrol all their workers into either an occupational scheme or the new NPSS. Individuals enrolled in the scheme will have to pay a standard contribution of 5% of salary, while employers would pay in an additional 3% - unlike the stakeholder scheme, there is no suggestion that the smallest employers should be excluded.

On the other hand, though, Turner suggests that any individual worker should be free to opt out of the NPSS. As ever, the pros and cons of compulsion are likely to figure heavily in the ensuing political debate about Turner. Whether individuals feel they need to save for a supplementary pension will depend to a large extent on what is eventually decided with the basic state pension - if that is set at a level which promises a comfortable level of income for those on relatively low-wage jobs, the temptation will for many be to opt for immediate consumption of their income rather than to save for a pension.

Save, save, save

But whether or not we end up with compulsion, there will still need to be some form of positive official encouragement for people to save, provided always that the system is seen to reward saving. And this encouragement will need to stress the importance of starting early. Research carried out last year for ACCA, by Ken Forman & Associates, underlined the long term effect of individuals delaying planning for their pensions. Assuming steadily increasing career earnings and corresponding pension contributions, and reasonable investment returns, a man or woman who starts saving at 25 can hope to buy an annuity which provides a pension worth almost twice as much as that available if they start saving only at 45. For the self-employed and those who have the means to boost their basic state rights, therefore, the message of early start and regular saving will remain as relevant as it always has.

Considering that the original remit of the Pensions Commission was to analyse the problems of the private pensions sector, it is remarkable that the report spends so little time considering how to revive confidence in it. The movement by employers away from DB schemes has been one of the stand-out issues over the last few years, and employers’ commitment to them is set to be tested further by the introduction of the pension protection fund levies in April. If anyone was looking to Turner to come up with ideas for tangible new incentives for staying in the DB market, they will be disappointed.

While the report does say that any new pensions settlement needs to maintain employer involvement in good quality pension provision, Turner seems to feel that this will amount to little more than employers doing their bit under the new NPSS. He refers, depressingly and in rather defeatist mode, to private company schemes as being “in serious and probably irreversible decline”. He also refers to a “decreasing belief among many employers that there are self-interested reasons to provide good pensions to achieve recruitment and retention objectives”. This latter finding in fact conflicts with recent research evidence (including a survey of employers carried out by ACCA in 2005) which found that both employers and employees still look upon good occupational schemes, whether DB or DC, as a competitive asset in the marketplace. There is a real danger, therefore, that Turner is undervaluing and undermining the contribution which occupational schemes are able to play in enabling people to accumulate good supplementary pensions.

After three years of thorough research, therefore, what the Turner report does not give us is a straightforward road map which is going to be acceptable across the board and easily adapted into law or regulation. Objections on the grounds of cost, of fairness and workability are already being raised and these and other arguments will no doubt be aired further when the Government follows up the report with a white paper sometime next year. Whether the full package of recommendations are adopted is anyone’s guess. But if ultimately the only achievement of Turner is to get the Government to grasp the scale of our savings deficit and the difficult choices that our society faces in reacting to it, it will have served an essential purpose.

John Davies is ACCA’s head of business law.