More on Government proposals to reverse decline in workplace pensions and restore trust
This news item sets out more on the Government's proposals contained in today's paper 'Reinvigorating workplace pensions'.
Keeping charges in check
The introduction of automatic enrolment into workplace pensions makes it more important to ensure pension schemes have clear charges that are value-for-money.
As smaller organisations start to automatically enrol their staff into workplace pensions over the next five years, the Government will monitor charges regularly across the pensions industry. The Pensions Minister will have the power to cap charges if he needs to.
The Government is also exploring the idea of a “star rating” system for pension schemes with the pensions industry. This would help employers choose good quality pension schemes. The number of stars might depend on how low the pension scheme charges are, how transparent they are and how well the pension scheme is governed.
Quality and value through scale
The Government is also keen to work with the pensions industry to look at whether a pensions market with a smaller number of larger, multi-employer workplace pension schemes might offer both employers and workers value for money.
Countries like Australia have these types of collective workplace pension schemes. While smaller schemes are still going to offer value in certain circumstances, larger schemes tend to be better governed.
The paper outlines the possible benefits of multi-employer workplace pension schemes and thoughts on how to bring it about. In Australia, for instance, pension scheme trustees are required to consider whether workers are being disadvantaged by being in a smaller scheme.
Automatically increasing pension contributions
Research shows that the level of contributions someone makes into a pension is the most significant factor influencing income in retirement when saving into a Defined Contribution (DC) pension scheme.
Under the new law requiring employers to automatic enrol their workers into a workplace pension scheme, the minimum level of contributions will be 8% of earnings by the time the programme is fully up and running in 2018. The employer will pay 3%, the worker will pay 4% and 1% will be paid in tax relief from the Government. This will only be paid on earnings between £5,564 and £42,475.
For many people, however, saving the minimum amount will not be enough to give them the level of income they would like in retirement. One way of encouraging people to pay more than the minimum, is by automatically increasing their pension scheme contributions when they get a pay rise. Once people have been signed-up, their pension scheme contributions would increase automatically when they get a pay rise.
At retirement, a DC pension pot has to be used to buy a retirement income (an 'annuity') from an insurance company. It is important for people to shop around to get the best annuity rate, because this will determine their retirement income for the rest of their life. To do this, they need transparent information. The Association of British Insurers has already launched a compulsory code of conduct for the insurance industry. The paper on 'Reinvigorating workplace pensions' also outlines alternatives to lifetime annuities. It encourages the pensions industry to explore more flexible ways for people to use their pension pot to best meet their income needs in retirement.
Defined Ambition (DA) has been put forward by the Pensions Minister, Steve Webb as a way of bridging a perceived gap between the two main pension saving models in the UK - Defined Benefit (DB) and Defined Contribution (DC).
In a DB pension, investment risk rests with the employer. This is because the scheme rules set out how much pension each worker gets at retirement and if there is insufficient money in the scheme to pay all the pensions, the employer has to pay extra money into the scheme.
With DC, workers' pensions depend on how much their pot is worth at retirement and how much it costs to buy their pension. Therefore, each individual worker takes responsibility for their savings level and risk profile.
With a DA pension, risks are shared, offering greater certainty to workers about the final value of their pension pot than in DC, and less cost volatility for employers than in DB. The Government wants to see how it can encourage and incentivise the pensions industry to develop and sell new DA pension products.
A number of potential new models for new “Defined Ambition” pensions are outlined in the Government's paper, examples include:
- Conversion of benefits - where the employer promises a defined level of benefit, and when the worker leaves the scheme by retiring or leaving the employment, the benefit is converted to a pot of an equivalent value - either to buy a pension, or transfer to a DC scheme.
- Moneyback guarantees - where a guarantee ensures a worker gets back at least what they put in. One way of doing this would be to have a moneyback guarantee funded by a levy on workers' pension pots. While an employer might opt to pay the levy for workers, it is likely the workers would pay the levy and the amount of levy would depend on the size of their pension pots. The cost could be kept down if the guarantee were provided by the private sector on a not-for-profit basis (a mutualised fund guarantee), or a Government-sponsored but industry-funded body, similar to the Pension Protection Fund.