Saving for a retirement income: Key issues for the 2015 Parliament
Ten years ago, the Pensions Commission concluded that the ageing population left society and individuals with four options: pensioners could become relatively poorer; public spending on pensions could rise; people would need to save more; or people would need to work longer.
Its analysis led to reforms to the state pension, increases in the state pension age and the introduction of auto-enrolment. Monitoring the implementation of these reforms and deciding whether more is needed will be an issue for the current Parliament.
As recommended by the Commission, the Labour Government legislated in 2008 to require employers to automatically enrol workers into a workplace pension saving scheme and, unless workers opt out, make minimum contributions to it (8% of qualifying earnings from October 2018 - 3% from the employer, 4% from the employee and 1% in tax relief).
The main target was those people on low to moderate incomes, particularly those working for small and medium employers, who were not saving enough for their retirement.
A simplified state pension
The previous Government continued with the policy of automatic enrolment: it was introduced in October 2012 and will be fully phased-in by October 2018.
However, it thought further changes would be needed to make auto-enrolment a success. In particular, it believed the complexity of the state pension made it difficult for people to plan for retirement. It legislated to combine the existing two tiers of the state pension into a single tier for future pensioners from 6 April 2016.
Current pensioners will continue to get a state pension under existing rules. The new state pension is to be set above the basic level of means-tested support (i.e. at least £151.25 per week in 2015/16).
The new state pension may encourage individuals to save for retirement. This is because, although communicating its effects will be a challenge in the transition, in the longer term it should be clearer to individuals how much state pension they can expect, which should help simplify decisions about saving.
However, the reform will also increase the responsibility on individuals to save privately if they are to achieve an adequate income in retirement. This is because, according to the Institute for Fiscal Studies, in the longer term the new state pension will be less generous than the current system for most people.
Improving defined contribution schemes
The reforms have focused attention on measures to improve the outcomes and value for money afforded by private pensions.
Defined benefit (DB) pension schemes are in decline in the private sector, with employers unwilling to bear the volatile costs involved. So, the vast majority of those auto-enrolled will go into defined contribution (DC) schemes.
The eventual income from such schemes is uncertain, depending on factors including future investment returns, any charges applied and decisions made at retirement.
Recognising that many individuals would not be comfortable with the risks involved, the previous Government legislated to enable the development of schemes able to provide greater certainty of outcome for individuals without cost volatility for employers.
However, it is not yet clear whether such schemes, dubbed ‘defined ambition', will become a significant feature of the pensions landscape.
A further concern has been whether more needs to be done to improve DC scheme quality and value for money. This is important because auto-enrolment entails workers, many on low incomes and with little experience of investment and savings products, being placed in a pension scheme without making an active choice.
A 2013 market study by the body then responsible for protecting consumer interests, the Office of Fair Trading, found that in these circumstances, competition between providers could not be relied upon to guarantee value for money.
The previous Government introduced a cap on charges in auto-enrolment schemes and changes to governance arrangements. The market will need to be closely monitored to ensure that it is working well for savers.
Is more needed?
For some, the combination of the new state pension and a private pension built up though auto-enrolment will provide an adequate income in retirement. The level at which the new state pension is set and how it is uprated will be important factors in determining what more is needed.
Although auto-enrolment has started to increase the number of pension savers, one potential downside is that people assume that contributing at the minimum rate is enough, only for some to find out too late that their savings are inadequate.
Chart: Memberships of workplace pensions
Membership of workplace pensions has risen with introduction of auto-enrolment. Active memberships of workplace pensions, as percentage of all employee jobs, UK
Some commentators have therefore suggested a policy of ‘auto-escalation', whereby minimum contribution rates increase in line with earnings increases.
However, it will be important to get the balance right, so that those who would otherwise benefit from saving are not prompted to opt out entirely.
Another proposal has been to reconfigure tax relief to provide better and clearer incentives to lower earners.
A further issue of concern has been the position of those earning below the ‘earnings trigger' for auto-enrolment (currently £10,000).
In any case, how to ensure adequate retirement incomes without placing an undue strain on the public purse is likely to continue to be a challenge.
Increasing the state pension age (SPA)
From the 1940s until April 2010, the SPA was 60 for women and 65 for men. From that date, the SPA for women started to rise and was due to reach 65 by April 2020. Under 2007 legislation, the SPA was set to rise from 65 in stages, reaching 68 by 2044. However, the previous Government brought forward the increases to 65, 66 and 67. It also established a framework for future increases, intended to ensure the costs of increasing longevity are shared fairly between the generations. Periodic reviews will consider the SPA in the light of life expectancy and other factors and will seek to give at least ten years' notice of any change.
- Conservatives: keep triple lock for uprating state pension; introduce single-tier state pension; reduce tax relief on contributions for people earning over £150,000
- Greens: citizens' pension of £180 pw for single person; reductions in tax relief; a new state earnings related scheme; uprating for pensioners in the UK and overseas
- Labour: Keep triple lock; ensure time to plan for state pension age (SPA) increases; reduce tax relief for highest earners; duty on pension providers to put savers first
- Liberal Democrat: Legislate for triple lock; continue with auto-enrolment and encourage people to save more; a single rate of tax relief; action on charges
- SNP: support for single-tier pension of £160pw; oppose abolishing savings credit; keep the triple lock; review SPA increases beyond 66; support for auto-enrolment; tackle unfair charges
- UKIP: flexible SPA; support for the triple lock and a simpler, single-tier state pension