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A New Pension Settlement for the Twenty-First Century
On 30 November the Pensions Commission, chaired by Lord Turner, published its second report on the UK pensions and retirement savings system. The report sets out the Commission's policy recommendations to the Government, with particular focus on whether the current voluntary system of pension provision should change. This article discusses the main recommendations. The full report can be downloaded from the Commission's website (www.pensionscommission.org.uk).
Background
The Pensions Commission was set up by the Government following the Pensions Green Paper in December 2002.
Its first report published on 12 October 2004 reviewed the current pensions situation in the UK and concluded that some combination of the following four factors would be necessary to cope with the retirement needs of our ageing population: poorer pensioners, higher retirement ages, higher taxes and higher savings.
The second report sets out specific policy recommendations to the Government.
Key recommendations of the Second Report
National Pension Savings Scheme (NPSS)
- Auto-enrolment - individuals required to contribute to NPSS unless they choose to opt-out.
- Contributions - employers to contribute 3% of pay, employees 4% and the Government 1%.
- Low-cost - maximum Annual Management Charge of 0.3% pa.
State Pension reforms
- Retain two-tier system - Basic State Pension (BSP) and State Second Pension (S2P) to remain but accelerate change in S2P from earnings-related to flat-rate.
- Change BSP accrual - base BSP on residency not contributions.
- State Pension Age - a gradual increase to 66 by 2030, 67 by 2040 and 68 by 2050.
- BSP linked to earnings - link the future level of BSP to earnings rather than prices.
- Means-testing curbed - freeze the pension credit in real-terms to stop mean-testing increasing.
- Remove contracting-out option - immediately for DC schemes, and phased out by 2030 for DB schemes.
Future policy recommendations
- Pension Advisory Commission - should be set up to report to the Government on developments in life expectancy and pension provision.
Barnett Waddingham LLP reaction
We welcome the recommendation that the State Pension Age is increased gradually, allowing for changes in life expectancy, which is a change we argued for in our response to the Commission's first report. However, the proposed gradual changes are not likely to keep pace with improving life expectancy, and more accelerated increases in SPA may prove necessary.
We are disappointed that the Commission has not thrown its weight behind allowing the same retrospective changes to retirement ages in occupational schemes.
We would have preferred to see a single enhanced State pension approach recommended rather than the two-tier system proposed which will remain more complex than we believe is necessary. We welcome the proposed change to the eligibility criteria for the BSP which will serve to help those with interrupted working lives.
We are disappointed with some aspects of the proposal for a new National Pension Savings Scheme. Whilst we view auto-enrolment in schemes as a positive step, we are concerned that the setting of a compulsory employer contribution rate of 3% of salary (for employees who also contribute) might lead employers to view this as a standard contribution rate rather than a minimum level of benefits. Employers with more generous schemes will be encouraged to keep them, but will they want to?
We would prefer to have seen contracting out scrapped completely, rather than phased out up to 2030 for defined benefit schemes.
Finally, we are disappointed that there are no new incentives to encourage ongoing defined benefit provision.
Some more detail on each of the key recommendations is provided below.
National Pension Savings Scheme
The NPSS is a national funded savings scheme where employer contributions are compulsory for employees who also contribute.
A key feature of the scheme will be auto-enrolment, meaning that unless new employees opt out within a month of joining an employer then they will start to have contributions deducted from their salary and paid into the NPSS. The level of contributions proposed is as follows, based on earnings above the Primary Threshold (currently £4,888) and below the Upper Earnings Limit (currently £32,760):
- Employee: 4% of net pay
- Employer: 3% of pay
- Government: 1% of pay (effectively the basic rate tax relief on the employee contributions)
Additional contributions by both employees and employers will be encouraged.
Contributions would be invested and held in individual accounts. Employees should be given a choice of 6 to 10 low-cost funds in which the contributions can be invested, with a default for those who do not make a choice. The proposed maximum Annual Management Charge is 0.3% pa.
Employers will be able to opt out of the NPSS if they offer more generous arrangements. The self-employed will be able to contribute on a voluntary basis.
State Pension Reform
The Commission acknowledges that State pension reform could be achieved by creating a single unified State pension or by retaining a two-tier system. Their preferred route is to retain the two-tier system with the following changes:
- Change the Basic State Pension (BSP) to be based on residency requirements rather than contributions over an individual's working lifetime.
- Accelerate the change in the State Second Pension (S2P) to an additional flat-rate pension, based on contributions.
- Link the level of the BSP to average earnings increases rather than prices. It is proposed to raise State Pension Age (SPA) for both BSP and S2P (although the report does not rule out the possibility of having different retirement ages).
It is proposed to increase SPA to 66 from 2030, 67 from 2040 and 68 from 2050 for both BSP and S2P (these ages would be reviewed in the light of new life expectancy studies).
It is proposed to remove contracting out for defined contribution (DC) schemes with all employees joining S2P for future accrual. For defined benefit (DB) schemes, it is proposed to phase out contracting-out by 2030 (the date by which S2P will become entirely flat-rate).
Alternatively, if the system of having different retirement ages were to be adopted, the age at which S2P becomes payable could increase to 69 by 2050 with the BSP being payable from age 67 and 3 months.
Finally Lord Turner suggests that his proposals could not be implemented until 2010 at the earliest. We have been waiting for reform for some time and it would be disappointing if the reforms cannot be completed at least by then.
Barnett Waddingham LLP, November 2005.