And They're Off - Pensions World January 2008

The race is on to avert a pensions crisis. Claire Lancaster and Glenda Ashison of Barnett Waddingham look at the distance covered in their article which first appeared in the January edition of Pensions World.

The world of pensions has been very busy in recent years. Many of the provisions set out in the relatively recent Pensions Act 2004 had not even come into force before the Pensions Commission produced its three Reports and a number of brand new hares were set running.

For those of you who are confused about where things came from, where they are and where they are going, here's a summary of some of the major milestones for the current reforms, together with the very latest position.

The Pensions Commission

The independent Pensions Commission was established by the Government in December 2002 and published three Reports between October 2004 and April 2006 amounting to an impressive 866 pages. The Commission was asked to consider the longer term challenges faced by the pensions system and whether the existing voluntary regime represented an adequate response.

It concluded that there was no immediate "pensions crisis" but outlined some key longer term challenges and the need for early action. In particular, the Commission recommended that it was appropriate:

  • to create a National Pensions Saving Scheme
  • to make reforms to the state pension to underpin private saving.

The First White Paper

Following the work of the Pensions Commission, the Government published a white paper in May 2006 entitled "Security in Retirement - towards a new pensions system". The paper noted great strides had been made, and that since 1997 two million pensioners had been lifted out of poverty. It went on to note, however, that it was "necessary to put in place an affordable and sustainable pension system which meets the needs of generations to come and encourages people to save for their retirement".

The Government set five tests, requiring that any reforms for the long term future of UK pensions must:

  • promote personal responsibility: tackling the problem of undersaving for retirement
  • be fair: protecting the poorest, and being fair to women and carers, to savers, and between generations
  • be simple: clarifying the respective roles of the State, the employer and the individual
  • be affordable: maintaining macroeconomic stability and striking the right balance for provision between the State, the employer and the individual
  • be sustainable: setting the basis of an enduring national consensus, while being flexible to future trends.

The white paper then went on to set out the Government's five proposals for reform to:

  • make it easier for more people to save more for their retirement by introducing Personal Accounts
  • provide a solid foundation to make the system of Personal Accounts effective
  • make the State Pension fairer and more widely available from 2010
  • support and encourage extended working lives
  • streamline the regulatory environment.

The Government subsequently issued a second White Paper in December 2006, entitled "Personal accounts - a new way to save". Unsurprisingly this "set out the Government's proposals for a new national system of low-cost Personal Accounts". A summary of responses to the consultation was published in June 2007.

The Pensions Act 2007

The establishment of the Personal Accounts Delivery Authority (PADA) was one of the key outcomes of the Pensions Act 2007. PADA is independently run and in its initial stage its remit is to:

  • provide advice and make recommendations to support the Government in understanding the operational and commercial implications of the options for delivering Personal Accounts
  • advise on the design of the commercial strategy, including the financial, technical, commercial and communications analysis needed for the development of the Personal Accounts framework.
  • Personal Accounts are to be targeted at low to moderate earners who don't currently have access to a good workplace pension. The intention is that they will be simple and low-cost.

Current proposals for Personal Accounts include contributions (based on specified earnings bands) from individuals of 4% per annum. These will be supported by a minimum matching 3% employer contributions, 1% tax relief and automatic enrolment of all employees aged between 22 and state pension age and earning more than around £5,000 per annum. Individuals will be able to opt out if they choose to do so. The introduction of a minimum employer contribution will hopefully increase incentives to save, and improve pension participation.

The Government have stated that their reform of private pensions through the introduction of Personal Accounts is intended to complement, rather than compete with, existing pension provision. Some of the measures which are to be taken to achieve this aim include the following.

  • a straightforward exemption process for existing schemes
  • a prohibition on transfers between Personal Accounts and other schemes, at least in the short term
  • an annual contribution limit for the Personal Accounts scheme
  • a higher annual contribution limit in the first year of the scheme

Recent changes to state pension provision as introduced by the Pensions Act 2007 include:

  • State Pension Age increasing to age 68 for both men and women by 2046
  • the Basic State Pension to be increased in line with earnings from 2012
  • the number of years' contributions required for a full Basic State Pension to be reduced.

The Financial Assistance Scheme

The last major Pensions Act, in 2004, established the Pensions Protection Fund ("PPF"). This was intended to be a safety net for members of salary-related pension schemes in the event that their employer becomes insolvent after 5 April 2005, the scheme did not start winding up before 6 April 2005 and the scheme does not have sufficient resources to pay a certain level of benefits.

The Pensions Act 2004 also established the Financial Assistance Scheme ("FAS") to help other individuals who had lost out on pension benefits, meet certain criteria but are not eligible to receive PPF compensation. The Pensions Act 2007 has now extended the reach of the FAS and increased the level of benefits payable.

The 2007 Act provides for FAS benefits to be paid at the rate of 80% of a member's core pension rights, subject to a raised cap of £26,000 per annum. A de minimis rule preventing pensions of less than £520 per annum has also been removed. The previously proposed cut off date for employer insolvency of 31 August 2007 has also been abandoned for the time being. As part of these reforms, the Government has now committed over £8bn to FAS - a dramatic increase from the £400m originally pledged!

Hurdles to jump

The Pensions Bill, laid before Parliament on 5 December would build on the major changes to UK pension provision as detailed in the Pensions Act 2007. In particular, it completes the legislative changes needed to set up the system of Personal Accounts and to enable PADA to move from acting in an advisory to an executive capacity.

Automatic enrolment (with the right to opt-out) of eligible employees is to form one of the key changes expected in the Bill and will hopefully help to tackle current behavioural barriers to pension saving. It is estimated that around 7 million people are not saving enough for their retirement.

The extent to which these changes and proposals represent a brighter future for the UK pensions system is the subject of much debate. Only time will tell.

Barnett Waddingham LLP, November 2007.