Reasons to be cheerful

In terms of the architecture of the pension system, many of the foundations of a sustainable and effective structure have been put in place.

First is the new flat rate state pension, which was implemented just six months ago. Although the transition from old to new system is slower and more complex than would be ideal, by the end of this Parliament most newly retired people will be getting the flat rate.  

Roll forward a decade and roughly four in five people will be on the standard rate when they retire. This means the majority of today’s workers can have a fair degree of confidence about how much their state pension is likely to be.

It would be fair to say that today’s workers have less certainty about what their state pension age is going to be.

But we can expect to spend two-thirds of our adult life in work and one-third drawing a pension. In addition, no-one should see their state pension age change within a decade of retirement.   

Building on the new flat-rate pension, the biggest achievement of the past few years has been the huge increase in membership of private sector workplace pension schemes. At time of writing, more than 6m people have been automatically enrolled.  

Although staying-in rates have edged down as smaller employers have started the process of enrolling their employees, the DWP’s revised assumption of 85 per cent staying in pensions looks likely to be reached. By the end of automatic enrolment we will probably be talking about 9m more people contributing to a pension than were doing so in 2012, which is a huge achievement.

Once a pension pot has been accumulated, consumers now have ‘freedom and choice’ about how they use their own money and this has made pensions more interesting and attractive to many. No longer forced into the straitjacket of an annuity, most savers seem to be using their new freedoms cautiously.  

Smaller pots are being cashed in to pay off debts or for modest luxuries – and why not? – but cases of people blowing their entire life savings on riotous living remain few and far between.  

In addition, the new Pensions Dashboard will, for the first time, allow people to see most (if not all) of their pensions in one place. This is not a panacea for the lack of engagement (after all, will the disengaged even bother to visit the dashboard?), but it will make life a lot easier for people who are starting to get interested in their pensions.

Does this mean that everything in the garden is rosy? Sadly not.

The biggest item of unfinished business in pensions policy remains tax relief. Pension tax relief has been the ‘go-to’ source of funds for cash-strapped chancellors, with repeated cuts to lifetime and annual limits, and mind-numbing complexity added to the system through tapered annual allowances and transitional protection for each cut in the lifetime limits.  

During the last election campaign the Conservatives said that apart from pre-announced changes there would be no further changes to pension tax relief in this Parliament. Many people would breathe a huge sigh of relief if this promise was kept. Although there are many things wrong with the current structure of tax relief, a period of stability would be welcomed.

In terms of automatic enrolment, although the growth in coverage has been hugely encouraging, there are two fundamental outstanding issues for the 2017 review – coverage and adequacy.

On coverage, the biggest gap is Britain’s ‘forgotten army’ of more than 4m self-employed people. Whereas pension scheme membership among employees has soared, coverage among self-employed people has continued to decline.  

Barely one self-employed person in four is contributing to a pension. This may not be a problem for better-off self-employed people who can live in retirement off the proceeds of their business and other assets, such as property or Isas. But growing numbers of self-employed people are not running small businesses. Rather, they are in many respects more like insecure low-paid employees, merely forced to operate as self-employed.   

Short of compulsory saving (which is politically infeasible) there are no easy answers to getting the self-employed saving more for their retirement. The Lifetime ISA (Lisa) has been touted by the government as being a good option for the self-employed because of its greater flexibility with regard to withdrawals compared with a pension. But given that most self-employed people are over 40 and Lisas can only be opened by the under-40s, this is unlikely to be the answer for most.

The best option in my view would be to have some sort of simulated automatic enrolment for the self-employed. One approach would be to build on the existing system of Class 4 National Insurance Contributions.  

This is a profit-related tax and is paid by roughly 2m self-employed people who file a tax return and have profits above a minimum threshold. One idea would be to raise the current standard rate of Class 4 NICs from 9 per cent to 12 per cent, but give the self-employed the option of redirecting the additional 3 per cent into a nominated pension scheme. This would be analogous to the 3 per cent employer contribution required eventually under automatic enrolment.  

The self-employed person would then top-up this ‘employer’ contribution with 5 per cent gross of their own, putting them in the same position as an employed earner on the same income. Such a scheme would offer one way of moving the issue of pensions and the self-employed out of the ‘too difficult’ box.

The other coverage issue frequently raised is that of those who earn below the £10,000 automatic enrolment threshold. In my view this is a much less serious problem than the omission of the self-employed. For those who always earn less than £10,000, a flat rate state pension of £8,000 provides a high degree of income-replacement post retirement. For those for whom low earnings is a temporary phase, their serious pension saving will happen when they have higher earnings.

However, when we get to 2019 we will still only be requiring workers and their firms to contribute 8 per cent of a band of ‘qualifying earnings’ into a pension. For the majority of workers, this is well below the level needed for a decent retirement.  

We urgently need creative thinking on how to get those contribution rates up without triggering mass opt-outs. For me, the only viable option is to build on the lessons of automatic enrolment by defaulting people into steadily increasing contributions if and when their pay rises.  

This ‘save more tomorrow’ approach is proven to work and is the least painful way of getting people to save more. Without this, far too many people will face the invidious choice between working ‘until they drop’ or retiring in relative poverty.

Steve Webb is director of policy at Royal London

Key points

Many of the foundations of a sustainable and effective pensions structure have now been put in place.

The biggest item of unfinished business in pensions policy remains tax relief.

There are no easy answers to getting the self-employed saving more for their retirement.