Can the Government reinvigorate workplace pensions?
The UK faces the double challenge of an ageing population and insufficient amounts of pension savings.
In its recent strategy paper Reinvigorating workplace pensions published on 22 November, the government laid out a range of options to tackle these challenges. However, the paper leaves a number of questions unanswered.
But first, some background. The stated objectives of the government are to ensure the sustainability of the UK pension system, to increase the amount people save in pensions and to increase the amount people receive for their pensions. The government already has a number of policies that aim to guarantee the sustainability of the UK pension system. For example, the increase in the state pension age to 66 has been brought forward to 2020, and there are plans to also bring forward the rises to age 67 and 68.
Furthermore, a white paper that proposes to introduce a single-tier state pension is expected to be published soon. The single-tier pension would provide a flat-rate benefit for pensioners above the standard guarantee credit level of pension credit. The aim of the single-tier pension is to ensure that those saving for retirement are able to do so with confidence, without worrying about their eligibility to means-tested pension credit to top up their state pension income.
And the most important government policy on workplace pensions has just started to be implemented. Automatic enrolment into workplace pensions is aimed at increasing the number of people saving into a pension, and the total amount of pension savings. The Department of Work and Pensions estimates that by the time the policy is fully implemented in 2018 there could be between six to nine million new savers into workplace pensions.
However, the strategy paper makes it clear that the current structure of workplace pensions does not ensure that people always get the most out of their pensions. So the government is looking at different ways to introduce more options into workplace pensions through defined ambition pensions. The overall goal of DA pensions is to provide more certainty about pension outcomes for members, while reducing the uncertainty surrounding costs for sponsors. This could be achieved by sharing some of the risks of pension provision between members and sponsors.
If we think of models of workplace pensions along a spectrum of who bears the risks, defined benefit pensions would be at one end with sponsors bearing the risks. In these schemes, the pension paid upon retirement is based on a formula that considers years of membership and average or final salary levels prior to retirement. Because the benefit is defined, the sponsor bears all the risks of pension provision such as increased longevity and investment risk.
At the other end of the spectrum there is defined contribution schemes, where a personal fund is built up with the contributions from the member and/or the sponsor. The pension paid is related to the returns on the assets in which members’ funds are invested and, if an annuity is taken, the annuity rate - the factor used to convert the member’s fund into an income. This design implies that the member bears all the risk of pension provision as, for example, the member will need to switch investments or increase contributions to ensure he accumulates a sizeable pension pot. This pension pot will need to be converted into a retirement income. If, on average, people are living longer, then annuity providers will reduce the annuity rates that they are willing to offer.