Recent research suggests nine million people in the UK are not saving1. The Pensions Bill currently before the House of Lords aims to encourage more people to make provision for their retirement and should therefore be widely welcomed. Unfortunately, it is impossible to say the key component of these changes, the new Government sponsored personal accounts scheme, is entirely positive because of the collateral damage that seems likely to accompany its introduction.
Let us be clear here. If personal accounts simply take large chunks of money from existing pension schemes then it will become the largest pension scheme in the UK. But it will be a spectacular policy failure.
It is crucial that the rules surrounding personal accounts are crystal clear in what success means, and how it is achieved. Policy success is not millions of people in personal accounts. Success is helping some of the millions of non-savers build up their own pension pot - whatever type of scheme that is in - increasing the overall level of savings in the UK in the process.
Unfortunately, the Pensions Bill has several key proposals which are likely to mean many current pension schemes close, or change for the worse. Measures which will largely penalise lower earning workers, the very people that many of the pension reforms are meant to benefit.
Key among these changes is a complex rule forcing the vast majority of employers to either change the basis upon which they calculate their pension contributions, or make continual checks and enter into complex discussions with members if they receive overtime or bonuses.
This is because payments to personal accounts are based on a band of earnings between £5,035 and £33,500. If an employer automatically enrols employees into either personal accounts or another good quality scheme, they need to make sure a contribution of at least 8% of this band of earnings is paid into the scheme. Of which the employer needs to pay at least 3%. The difficulties arise as the Pensions Bill defines earnings as total earnings in this band, including bonus, overtime and commission. In contrast, the vast majority of existing schemes base contributions on earnings from £1 upwards but only use basic salary.
If an employer wants to retain their existing contribution basis they need to check the contribution made to their scheme is at least as high as would have been paid using the personal accounts definition. And this needs to be done each pay period - monthly for most people. As the check is done monthly, people can 'fail' if, in one month, they receive a commission or bonus payment. So while, over the whole year, the individual would be better off in their employer's scheme, they fail the Government's test in one month. The employer then needs to tell the employee this and may ask them for an additional contribution to make sure they remain a 'qualifying member'. If this doesn't happen the employee may have to be enrolled into personal accounts.
The administrative complexity of doing this check each pay period, and the adverse impact it will have on employer/employee relations, means many employers will seek a simple solution. An obvious route is moving to the same definition as personal accounts - ignoring the first £5,000 of earnings but including bonus etc. The employer could even introduce this for lower earnings staff while keeping the existing definition for staff above the upper threshold of £33,500 where the problems don't arise.
Even if only some people will fail the test the employer will change the definition for many or all staff, meaning many people will lose out. The Government will point out that commission and bonus will be taken into account even though the first £5,035 of earnings is ignored. But do those on low earnings receive more than £5,000 by way of overtime, bonus and commission? The short answer is no, with women in particular losing out. For men, additional earnings account for 8 per cent of total weekly earnings compared with 3 per cent for women2.
Continuing down this path will mean that lower earners, especially women, will lose out and receive lower pension contributions from their employer. Surely this isn't what the Government wants to achieve?
Allowing employers to continue to base pension contributions on basic pay is a much simpler conclusion. This approach could come with appropriate safeguards to ensure that employers can't abuse the position, by paying low salaries and high bonuses. And it will mean low earners aren't unduly punished by the Government.
Another significant issue in the Bill surrounds the Personal Account Delivery Authority. PADA has been set up to establish personal accounts. Once the scheme has been set up, PADA will be wound up, with a trustee body taking over the ongoing responsibility for personal accounts.
You would imagine that PADA's duties would be restricted to advising Government on the personal accounts scheme. This might cover issues such as scheme design, charge levels and shapes, the tender process for contracts to operate personal accounts and so on.
However, the Bill gives PADA much wider ranging powers. For example, it will advise the Government on the test which determines which existing schemes are allowed to be exempt. By giving PADA these powers, it has the ability to shape the regulatory environment in which other pension schemes can compete with personal accounts.
This introduces a clear conflict of interest. Personal accounts success could come at the expense of the large scale destruction of existing provision if the regulatory scales are tipped too far in their favour. As PADA's main role is to deliver successful personal accounts, its ability to influence the rules under which existing schemes operate is clearly anti-competitive.
PADA's powers should be restricted to advising government on establishing the personal accounts scheme. To make sure employers enrol workers into the scheme as they are required to do. Any decisions about the rules under which existing schemes operate should be the responsibility of Government, without influence from PADA.
Another part of the Pensions Bill will allow taxpayers' money to be used to subsidise personal accounts. The Government will be allowed to provide grants and interest-free loans to cover the start up costs of the personal accounts scheme.
As personal accounts will compete directly with existing pension provision, it is important that this scheme competes, and is seen to compete, on a level playing field. In other words, the taxpayer should not subsidise the creation and development of personal accounts.
As this Pensions Bill goes through Parliament we need an open and honest debate around how we achieve the holy grail of getting more people to save more money. Getting lots of money into personal accounts is one measure. But if this is achieved at the expense of existing savings, it will be an illusion of success. Unfortunately, some measures within the Bill give a clear advantage to the personal accounts scheme. And the frankly ludicrous contribution checks which employers will need to carry out will push many employers to reduce pension contributions for the lower paid. These issues need to be publicly debated before we sleep walk into a change which penalises the very people which pensions reform is meant to help.
Andrew Tully
Senior Pensions Policy Manager
This article is based on our current understanding of the proposed Personal Account legislation being introduced in 2012.
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