Mind the gap: the extent that UK government pension reforms address the issues of those in low pay

Transcription

1 Mind the gap: the extent that UK government pension reforms address the issues of those in low pay MARCUS WHITING Research Fellow, Institute of Applied Social Studies at the University of Birmingham Abstract In 1998, Labour s introduced their flagship policy, the Stakeholder Pension (SHP), which affirmed their commitment to increase the private sector s role in pension provision. Yet failure of this policy to reach its target group led the government to set up a Pensions Commission, which questioned the need to go beyond the voluntary approach. The resulting White Paper: Personal Accounts: a new way to save (delivered in December 2006) aims to establish automatic enrolment for those without second-tier pension provision in order to remedy the inertia experienced with the SHP, underpinned by an improved Basic State Pension (BSP). However, as with its predecessor, Personal Accounts are private sector pensions that offer no guaranteed returns on retirement. This paper examines these policies with respect to the low paid and challenges government thinking that ignores the ability of this group to contribute significant earnings to make such a pension viable. It argues that individualisation of risk does not fall evenly on the population as a whole. Moreover, the government s concept of low pay falls short of that defined by the Low Pay Unit and the Council of Europe. Finally, it makes the case that the solution is to acknowledge the true extent of low pay and rather than state marginalisation in pension provision there needs to be an enhanced state earnings related second pension underpinned by a universal BSP in line with its true value had the link with earnings not been broken. Introduction Following the election of a Labour government in 1997 there were expectations that many social policies introduced by the previous Conservative governments would be reversed. However, New Labour, were in many policy areas to break from their social democratic past and embrace the neo-liberal policies of their predecessors (Hefferman 2003). This was particularly evident in their approach to pension provision, where they committed themselves to an extension of private individualised provision. Key to this was to be the Stakeholder Pension (SHP). However the SHP has failed to attract significant interest, particularly amongst the target group; those on incomes between 10,000 and 20,000 p.a. (House of Common Research Paper, 01/69, 2001, p.7). Despite attempts to simplify the UK s pension framework in their Green Paper: Simplicity, security and choice: working and saving for retirement, which aimed to allow the vast majority of people to save more in a pension that existing rules allow (Department for Work and Pension (DWP) 2002, p.5) and provide better information about financial products available; helping people to make informed choices (ibid.) the take-up of the SHP continued to fall below expectations. In reaction to this and growing criticism from both the political left and right the government set up a Pensions Commission in order to remedy these concerns. The Pensions Commission concluded that a National Pension Savings Scheme (NPSS) in which employees would be auto-enrolled and included employer contributions would be required to counter the inertia experienced by the SHP. This was to be underpinned by an upgraded BSP, part paid for by increasing the state pension age (SPA) and a small increase in GDP spending; reversing the government s 1998 objective. More recently the government has published a White Paper: Personal accounts: a new way to save (DWP, 2006b) in which much of this advice has been taken on board.

2 This paper analyses the likely success of these proposed changes. It is divided into four sections. The first section examines the characteristics and success of the SHP. The second section discusses the findings of the Pensions Commission and the extent to which their proposal addresses the issues that concern the low paid. The third section outlines Labour s policy response to the Pensions Commission s findings. The final section will analyses the government s proposed reforms with respect to those on low pay and the extent they address the real world issues of the low paid. Introduction of the Stakeholder Pension (SHP) In April 2001 the government introduced the SHP, a defined contribution (DC) money purchase scheme (MPS). This they argued would be a cheaper and safer personal pension (PP) aimed at the middle income earners (those with earnings between 10,000 and 20,000 p.a.) who were not currently in an occupational pension scheme (OPS) (op. cit.). The SHP was to be a voluntary scheme that employers would be compelled to offer their employees if they had 5 or more employees and no alternative OPS in place. Anyone interested in a SHP would then be able to expect their employer to administer the scheme on their behalf. In addition to this, the SHP would be marketed by banks, insurance companies and building societies. This option would involve contracting out of the S2P; thus the government s marketing strategy, rather than compelling employees to join a SHP, was to increase their awareness of the scheme. The SHP was a clear indication that Labour intended to further marginalise the state s role in pension provision and continue down the road of privatisation. In the Green Paper: A new contract for welfare: partnership in pensions (Department of Social Security (DSS), 1998) the government stated, we are building a new contract for pensions between the state, private sector and the individual. We believe that those who can save for their retirement have the responsibility to do so, and that the State must provide effective security for those who cannot (DSS, 1998, p.iii). The government, whilst accepting they had a minimal role to protect the poorest in society via pension provision, intended to reverse the public/private balance of pensions income then 60:40 by 2050 (ibid. ch4, para.18). Importantly, Labour recognised the misselling scandals associated with the PP, particularly for those who were encouraged to opt out of a decent OPS. In order to reduce the likelihood of this reoccurring, the SHP was to operate within a new regulatory framework with minimum standards. Companies that offered a SHP would have to apply to the Occupational Pensions Regulatory Authority (OPRA) for registration, whilst the Financial Services Authority (FSA) would be responsible for regulating the sale and promotion of the SHP (see ibid.). Hence, the intention of the government is to find a balance between helping the neediest whilst clearly stating the responsibility of others to save. Despite the SHP being a flagship policy it never achieved the government high hopes. Research at the time by the Association of British Insurers (ABI) found that while 1.25 million stakeholder plans have been sold since the scheme s launch, the average contribution has been 155 a month. This suggests that people on incomes of less than 20,000 p.a., the original target market, are not buying the plans (ABI, 2003, August). Significantly the way in which the SHP had been designed has attracted higher earners (those earning above 30,000 per annum). As Chung et al stated, this [is] because higher rate taxpayers can go on to claim more relief in line with their higher marginal income tax rate (2004, p.6 and table 3.2, p.10).

3 The failure of the SHP to reach its target group is of particular interest. Firstly, by aiming it at those earning 10,000 p.a. was misconceived. This is because that those earning less than 16,000 p.a. are unlikely on their income investment alone to make a SHP a viable alternative to the S2P and escape means testing (the Pension Credit level). As Frank Field suggested anyone earning below 16,000 p.a. is safest in the S2P (The Guardian, 2001, 17 th August). This in part is based on the government s definition of low pay, which in April 2001 was 11,544 p.a. and well short of the definitions set by the Low Pay Unit and the Council of Europe, which were 14,119 p.a. and 15,707 p.a. respectively (see Whiting, 2006, p.95, table 3.1 for definitions). Thus many of those considered as middle income earners by the government are regarded as low paid by the LPU and the Council of Europe. This coupled with the fact that the SHP is a DC MPS as opposed to a defined benefit (DB) pension that shifts the investment risk onto the individual; away from the employer and the state. Thus the SHP by design is inappropriate for those on low pay, which is exacerbated by the government s avoidance to address the ability of those in their target group to contribute significant income into a SHP to make it a viable option. Instead the government s focus is to tackle attitude, approach and awareness to save for retirement. It is presumed that people are not putting sufficient income aside for retirement owing to a negative attitude towards saving and that by increasing awareness and financial security of the SHP the solution to approach can be addressed. However, the low paid actually have a positive attitude to saving for retirement but their lack of financial resources prevent them putting aside additional income for their futures (ibid. p.199). The assumption is that people, who include the low paid by definition, should make additional contributions towards a DC MPS under the rhetoric of rights and responsibility (see White, 1999). Coupled with the omission that many in the SHP target group lack the resources to make it viable is the government s concept of awareness, which focuses on availability rather than understanding. Consequently, the risks involved in investing into a SHP are never sufficiently explained and increasing financial security for those on low income in a DC MPS is actually misleading as many are unaware that their final pension fund will depend on how successfully it is managed, the vagaries of the stock market and the administration costs (see Schulz, 2000, pp ). For example, even the low predicted administration cost of the SHP (1.5 %) can result in a 38% decrease of funds over a lifetime of investment (DWP, 2006b, p.92). There are also additional risks when in receipt of the fund, as purchasing an annuity is fraught with risk no matter how long they are deferred. Not only is timing of retirement critical because of market vagaries but variation in annuities are complex, for instance, women can expect a lower annuity on the same fund as a man because of their higher predicted longevity (Equal Opportunities Commission, 2002, 9 th May). Significantly, this shift of responsibility onto the individual to provide for their own pension will potentially expose many on low pay to a number of problems including misselling, which is exacerbated by the reality that most people have little or poor knowledge on how the risks in pensions are allocated (Ring, 2003, p.69). In summary the SHP does not address the low paid s ability to put aside sufficient contribution to make it a viable option and most would still be reliant on means tested support. Moreover, the government downplays the extent knowledge is required to understand the risks involved in what is a lifetime of investment that will affect adversely those on low pay. The failure of the government s SHP to reach their target group has led to them setting up the Pensions Commission as growing criticism from both the political left and right ensued.

4 Setting up of the Pensions Commission and the National Pensions Saving Scheme (NPSS) The Pensions Commission was set up in 2002 owing to the failure of the SHP, in order to address the adequacy of private pension saving and to advise on policy change, namely, is there a need to move beyond the voluntary approach (Pensions Commission, 2004, p.v). It concluded that faced with a growing proportion of the population aged over 65, society and individuals must choose between four options: 1. pensioners will become poorer relative to the rest of society; or 2. taxes/national Insurance contributions devoted to pensions must rise; or 3. savings must rise; or 4. average retirement ages must rise (ibid. p.x). It further suggests that as the first option appears unattractive then it has to be a mixture of the other three options (ibid.). The Pensions Commission finally published their recommendations in November 2005 and based on their conclusions argued that to increase savings into a private pension there is a need to limit the rise in means testing (2005, p.17). The current system has created a BSP declining in value in real terms that is topped up by the means tested Pension Credit. The system as it stands will leave many who choose to save via the SHP reliant on Pension Credit, which acts as a disincentive to save. In order to counter this problem the Pensions Commission have suggested introducing either an Enhanced State Pension or building on the BSP and the S2P to produce a flat rate first-tier state pension that would be at the current Pension Credit level ( 114 per week for a single person), which would then be annually upgraded with earnings. The recommended time schedule for this change on account of cost to the state is 2010 or 2011; paid for by the rise in the SPA for women (ibid. p.21). This, they argue would further encourage saving into a private pension as the system would be less complex and more accessible. The Commission s recommendation is for a universal first-tier provision, namely, based on residency as opposed to NICs as this avoids the problems suffered by women and the low paid owing to incomplete working patterns. They recommend the gradual introduction of the universal pension to counter costs (ibid. p.208) but believe that for those over 75, this should be introduced immediately (ibid. p.21). In order to achieve minimal cost to the state the Commission proposed that these changes are shared between the state, employee and employer. The government needs to be prepared to increase GDP spending currently 6.2% GDP to between 7.5% and 8.0% by 2045 (ibid. p.21). Individuals will have to accept that we are now living longer and there needs to be an increase of the SPA, albeit over a thirty year period, from And employers would be compelled to contribute to the NPSS. The scheme would be financed by a total 8% of contributions from earnings between the primary threshold (the level of income at which tax and NICs become payable, currently 4,888 p.a.) and the upper earnings limit (UEL) (ibid. p.355). The breakdown of the contributions will be 4% from employees, 3% employer and 1% tax relief (see ibid. p.7 for more detail). Unlike the voluntary structure of the SHP, employees excluded from an OPS will be automatically enrolled, with the option to opt out, in order to counter the inertia to save for retirement. The value of auto-enrolment is that it decreases the importance needed to market the scheme and reduces the need to focus on attitude, approach and

5 awareness of individuals as required by a voluntary scheme. Instead the focus then shifts towards retaining those that have been auto-enrolled into the scheme. In order to encourage people to remain in the NPSS, the Pensions Commission claim that their scheme would be cheaper to run owing to the increased numbers that would be in the scheme, stating that annual management charges (AMC) will be 0.3% (ibid. p.396) as opposed to 1.5% the current administration cost of the SHP. Moreover, they claim, based on reasonable assumptions about rates of returns and years of contributions this might secure the median earner a pension at the point of retirement about 15% of median earnings in addition to the upgraded BSP (ibid. p.7). Assertions that the NPSS will be cheaper to run, avoid inertia and encourage those in SHP target group to save for retirement in a private sector pension have come under some criticism. It has been argued that the proposed changes are too cautious. As Lynes argues, although it welcomed that the Commission intend to introduce an improved BSP and one that in future has a universal approach, which would resolve many issues surrounding insufficient NICs; this simply does not go far enough. First the increase to 114 per week is still 23 per week short of the value of the BSP had it remained linked with annual increases to prices or earning, whichever the higher and that this change will be delayed on the account of affordability to 2010 or 2011 (2006, para1.5). Second that the concept of a universal BSP as welcome as it goes... it is hard to see any logical justification for limiting it to those over 75 or 80. Moreover, no specific date is proposed for its introduction and it remains to be seen whenever the government will regard it as affordable (ibid. para.1.6). A key to the success of the NPSS is the upgraded state pension acting as a foundation to reduce reliance on means testing, the current proposal could find many on low pay having their pensions savings cancelled out by means testing owing to the Commission s cautious approach to the upgrade of the BSP both in its timing and its level. As the Pensions Reform Group state, the Pensions Commission proposal blow this once in a life-time opportunity by proposing reforms which will not achieve the long-term goal of taking practically all future pensioners off means-tested benefit (2006, p.1). Consequently, many on low pay may be advised to opt out of the NPSS further damaging the likelihood that the low 0.3% AMC will be achieved, which in part is based on predicted participant rate, via auto-enrolment, of 80% (For full debate on the AMC: why 0.3% is more than optimistic see House of Commons Treasury Committee, 2006, Ev.107). A further problem is that of employer contributions, setting this at 3% could see a levelling down of other company schemes (ibid. Ev.119). Not only this, employers may counter costs of this contribution by holding back wage increases or discourage employees not to join the NPSS altogether. As the Tomorrow s Company argues, compulsory employer contributions could see future salary increases for [those on low income] (and other workers) reduced in compensation (2007, p.5). Finally the NPSS is a DC MPS, therefore there are no guarantees on returns, and even the Pensions Commission proposal states that the NPSS might secure the median earner 15% of median earnings [at the point of retirement] in addition to the upgraded BSP (Pensions Commission, 2005, p.7). Thus the Pensions Commission proposal fails to address the key issue of ability, namely the potential of the low paid to contribute sufficient earnings to avoid means tested benefits, ignoring the fact that as Taylor-Gooby identified, individualised risk does not fall equally on all sections of society (2001, p.196). Moreover, it has been argued

6 that the NPSS benefits the higher earners most as there is minimal redistribution of wealth within its structure (Pensions Policy Institute (PPI), 2006, July, p.12). Labour s policy response to the Pensions Commission s findings In the White Paper: Security in retirement: towards a new pensions system, the government overviews the pension system and their progress since 1997 along with the Pensions Commission s recommendation. The paper aims to set out a new structure for the UK pensions system for the long term (DWP, 2006a, p.v). And based on the Pensions Commission s findings, they state we can lay the foundation on which this generation and the next can work and save for a long and healthy retirement. And they can do so in confidence that the reforms we are proposing will last between the generations (DWP, 2006a, p.v). Moreover, they stated that the Pensions Commission has made clear, we face some stark choices about the path ahead. We don t want retirees of the future to be worse off than those today. But neither should our response be simply to spend more public money on the State Pension alone. A new balance must be struck between State, employers and individuals to share the responsibility to save and provide for the future (ibid.). A key difference to the government s SHP policy is that by embracing much of the Pensions Commission s proposals, the government will have to curtail their aim to reverse public sector spending, employers will be compelled to contribute whilst the employee will have to pay by extending their retirement and if they remain in the scheme by contributing a minimum of 4% of their earnings. Although accepting much of the Pensions Commission s recommendations, the government s new scheme of personal accounts, effectively the government equivalent to the NPSS, has important differences as they propose: 1. relinking the BSP s to average earnings in 2012 subject to affordability and fiscal position; 2. streamlining the contribution conditions to the BSP by reducing the number of years needed to qualify to 30; 3. replacing the Home Responsibility Protection (HRP) with a new weekly credit for those caring for children; 4. introducing a new contributory credit for those caring for severely disabled people for 20 hours or more per week; 5. abolishing the initial contribution condition to the BSP, so that caring for children or the severely disabled will build entitlement to the BSP, without having to make a minimum level of contribution; 6. making a number of other simplifications to the rules for entitlement to the BSP and S2P, and abolish a number of complicated and out-dated provisions such as adult dependency increases and autocredits (ibid. pp.17-18). Significantly the change to a universal pension has been rejected. In December 2006, the White Paper: Personal accounts: a new way to save aimed to build on the Commission s proposals for reforms to promote private savings. A new system of personal accounts will extend the benefits of low cost savings to those without access to good occupational pensions. For the first time there will be a matching compulsory employer contribution. We ll make sure individuals do not miss out by automatically enrolling them into the scheme (DWP, 2006b, p.3). This White Paper is merely ratification of the proposed changes forwarded in the May 2006 White Paper. The extent that the government s proposals address low pay by comparison to the changes forwarded by the Pensions Commission is of interest. Firstly by further delaying the

7 changes and with no intention of introducing a universal pension their proposal is less likely to be feasible to the low paid. This is despite some changes to the current NICs as many in low pay still are unlikely to make Personal Incomes a viable option compared to an upgraded decent SERPS/S2P. Many will still be reliant on a means tested retirement, (PPI, 2006, July, p.12) which could have been considerably reduced by introducing a Universal Pension set at per week for an individual (the BSP level if its link to earnings had not been broken). The final section analyses the failings of the government s proposal to create a more simplified and decent pension for those in low pay by looking at the real world issues that up to now have been played down or simply ignored. The real world The failing of the SHP to reach its target group, was the inability of the government to address the ability of those in low pay to contribute significant earnings to make a DC MPS a viable option. This in part was owing to an insufficient BSP in place that would effectively mean that many would be reliant on the Pension Credit. Their focus was to address attitude and approach and awareness of saving for retirement. Yet significantly, the low level of the BSP and the failing of the PP, the SHP s predecessor, have created a pension system that many simply do have much trust in. As research by Bunt et al stated, the majority of individuals were uncomfortable with the concept of risk in the context of pensions. They felt that it was inappropriate to take risks with such an important investment (2006, p.4). For those that are willing to save they rather invest money elsewhere, such as in property if the opportunity is available to them (Whiting, 2006, p.226). The response to this was to set up a Pensions Commission to challenge the voluntary approach, it was accepted that much needed to be done to redress the savings deficit implicit in the current system. They argued that people, including those on low pay, are not saving enough. With criticism from both left and right political camps that the current system is failing those on low pay as well as middle income earners, there was a consensus that the state needed to do more in pension provision (for full debate see ibid. pp ). One part of the solution was to upgrade the BSP to at least the Pension Credit level and relink its annual upgrade to earnings or prices depending on whichever was higher. This was the Pension s Commission s recommendation but owing to affordability the proposal is set for either 2010 or In addition it was proposed that the BSP should be universal. The government s response to these conclusions is to further delay the relinking of the BSP to earnings until 2012, whilst rejecting the concept of a universal pension despite sufficient evidence that the majority of this proposal could be paid for by scrapping contacting out rebates and other means (PPI, 2006, July, p.11). Interestingly the Pensions Commission never addressed any improvement to the S2P an ideal opportunity to redress the inequalities in the pension system experienced by those in low pay employment (see Lynes, 2006, p.1). Instead, it searched for a private sector solution and on the ground of affordability concluded that an improved pension system would have to be paid for by the state, employer and employee. This may seem a reasonable conclusion but ignores the fact that the state and employer have, for many employees, reduce their contributions over the last two decades breaking with the tripartite principle that underpins the concept of the welfare state. In place we have a watered down solution that places the responsibility of risk onto the individual, which for those on low pay is too much to bear. The government approach is to adopt the Pensions Commission s auto-enrolment solution to tackle inertia to saving as part of the rights and responsibility rhetoric. However, this recommendation simply forces the low paid to take risks despite their lack of awareness to how they are allocated in the current

8 pension system. This will cause confusion as many will not know if they will be better off to opt out or remain in the system. The fact is that the Personal Incomes system is a DC MPS and cannot offer a guaranteed a retirement fund even both the government and the Pensions Commission admit their claims to the final fund amount are no more than estimates (Pensions Commission, 2005, p.7 and DWP, 2006, p.5). Therefore, the risk is implicit but further exacerbated by a pension system that rather being simplified will actually be more complex. For example: there will be more NICs rules that a universal BSP pension could have removed; the existence of the Pension Credit savings credit calculation will remain; the S2P will continue but with a time frame to it being changed to flat rate yet to be confirmed and further to this the delayed proposal changes to the BSP result in different rules for many according to age. The solution therefore is to accept that individualised risk does not fall equally on all member of society and the government needs to increase its roll in pensions provision by redistributing earnings via an earnings related state second pension scheme that is in line with the more generous SERPS. When those on the political right accept that there is only so much the private sector can do for those in low pay with respect to pension provision this could easily gain political consensus, leaving only those who can afford the risks relying on a DC MPS. Significantly, debate on what the public would be willing to contribute towards an improved guaranteed state pension has not even been tabled. However what is clear is that the private sector via the DC MPS had failed to come up with a viable pension for those on low pay and as a consequence, the government needs to mind the gap between their definition of low pay and that of LPU and Council of Europe. References Association of British Insurers. (2003). Stakeholder Pensions Time for change. August. London: ABI. Bunt, K., Adams, L., Koroglu, Z. & O Donnell, E. (2006). Pensions and pension reform. DWP Research Report No 357. Norwich: Her Majesty s Stationery Office. Chung, W., Disney, R. Emmerson, C. & Wakefield, M. (2004). Public policy and saving for retirement: Evidence from the introduction of Stakeholder Pensions in the UK Available from [Accessed 8 March 2007]. Department of Social Security. (1998). A new contract for welfare: Partnership in pensions. London: The Stationery Office. (Cm; 4179). Department for Work and Pensions. (2002). Simplicity, security and choice: Working and saving for retirement. London. The Stationery Office. (Cm; 5677). Department for Work and Pensions. (2006a). Security in retirement: Towards a new pension system. London. The Stationery Office. (Cm; 6841). Department for Work and Pensions. (2006b). Personal accounts: A new way to save. London. The Stationery Office. (Cm; 6975).

9 Equal Opportunities Commission. (2002). Pensions system makes women even poorer in retirement. Available from [Accessed 8 March 2007]. Field, F. (2001). Why Mr Blair should rethink his pension. Guardian Unlimited. 17 August. Available from: [Accessed 18 October 2001]. Heffernan, R. (2003). New Labour and Thatcherism in A. Chadwick & R. Heffernan (eds.). The New Labour Reader. Cambridge: Polity Press. House of Commons Treasury Committee. (2006). The design of a National Pension Savings Scheme and the role of financial services regulation: Fifth Report of Session Volume II Oral and Written evidence. London: The Stationery Office. Jarvis, T. (2001). Stakeholder Pensions. House of Commons Library Research Paper 01/ August London: House of Commons Library. Lynes, T. (2006). Memorandum submitted to the UK Parliament. 30 May. Select Committee on Work and Pensions Written Evidence. Available from m. [Accessed 8 March 2007]. Pensions Commission. (2004). Pensions; challenges and choices: The First Report of the Pensions Commission. Norwich: The Stationery Office. Pensions Commission. (2005). A new pension settlement for the twenty-first century: The Second Report of the Pensions Commission. Norwich: The Stationery Office. Pensions Policy Institute (2006) An evaluation of the White Paper state pension reform proposals. July. London: PPI. Pensions Reform Group. (2006). Developing alternative approaches to a National Pensions Saving Scheme. Available from [Accessed 15 February 2007]. Ring, P. (2003). Risk and UK Pension Reform. Social Policy & Administration. 37, (1), pp Schulz, J. (2000). The risk of pension privatisation in Britain. Challenge. 43, (1), pp Taylor-Gooby, P. (2001). Risk contingency and the third way: Evidence from the BHPS and qualitative studies. Social Policy & Administration. 35, (2), pp Tomorrow s Company. (2007). Select Committee on Work and Pensions: Comments on the proposed system of Personal Accounts. 15 December. London: Tomorrow s Company.

10 White, S. (1999). 'Rights and responsibilities: a social democratic perspective' in A Gamble & T Wright (eds.). The New Social Democracy. Political Quarterly. Oxford: Blackwell. Whiting, M. (2006). Low pay and pensions: Planning for old age in a real world of insecurity, financial constraints and competing demands. A PhD thesis submitted to Middlesex University. London: Middlesex University. NB: this paper cannot be distributed or quoted from without the permission of the author.