The Government has published the second part of its plans to improve pensions. Part one set out changes to the state pension (see Saga Magazine August 2006). Part two is about encouraging pension saving at work.
From April 2012 every employee aged from 22 to state pension age who earns at least £5000 a year will be automatically enrolled into a pension scheme at work. That will help up to 10 million people who choose not to join their work scheme or whose employer currently does not offer one. In future employers without a pension will have to take part in a new National Pension Savings Scheme (NPSS).
Employees will be able to opt out of the NPSS. But if they do they will be re-enrolled every three years or when they change jobs. So to stay out will take a lot of effort. The evidence shows that automatic enrolment means far more people join than the present system where people have to opt in. People under 22 or over pension age will not be automatically enrolled but will be able to join the scheme if they choose, though there will be an upper age limit of 75.
If an employee stays in the NPSS then the employer will have to pay into the scheme. There will be no exemptions, even for very small businesses. An employer with just one employee will have to offer the NPSS. The only exception will be employers who already offer a company scheme which is at least as good. They can carry on with their present scheme but will still have to follow the automatic enrolment rules.
Contributions into the NPSS will be 5% from the employee and 3% from the employer of their gross pay from £5000 to £33,000. Employees will get tax relief on their contribution. So the 5% will actually cost them 3.9% of their take home pay. The other 1.1% will come from the tax relief. The employer will also get tax relief – and pay no National Insurance – so their contribution will cost them rather less than 3%. In addition the employer’s contribution – but not the employee’s – will be phased in over three years at 1% in 2012, 2% in 2013 and the full 3% from April 2014.
Employees will be able to pay in more than 5% but total contributions will be capped at around £5000 a year. In the first year of the scheme the limit will be doubled to £10,000 to encourage people to start saving now and transfer the money to the NPSS when it starts in 2012. The employer will be under no obligation to match any extra paid by the employee, though of course they can choose to do so within the overall £5000 limit. The three million self-employed people will also be able to save into the scheme – with no lower limit. People earning under £5000 can also join but the employer will not be obliged to pay in.
Charges
However much we put into our pension pot, there is a little hole in the
bottom called ‘charges’. Each year money leaks away to the company that runs the
fund. On average they take 1.2% of our money each year and some drain off a lot
more. This fee pays for the cost of advertising, the cost of selling pensions to
other people, the cost of conforming to regulations and the cost of managing the
investments. The Government wants the charges of the NPSS to be much lower –
0.3% in the long-term which is a quarter of the average amount charged now. It
believes the industry can do this because it will not have to sell NPSS pensions
– which normally costs £800 a time – and because the funds generated will be
very large. It estimates that £8 billion a year will go into the NPSS and that
will make it cheaper – per pound – to run. Similar national funds in other parts
of the world are run for 0.3% a year or less.
Costs will also be kept down by limiting the choice about where the money is invested. At the moment there are thousands of different pension funds all invested in different ways in various types of asset all around the world. The NPSS investments will be simple with very limited choices and that will keep costs down. It will also have the big advantage that people will not have to make difficult decisions about where they want their money to be invested. If you do not choose anything your money will be put in one big ‘default’ fund invested by the NPSS in a broad range of investments that should be safe if unspectacular.
Low contributions
Commentators agree that the Government’s plans will increase the number of
people contributing to a pension and the amount of money being saved for
retirement. But critics are worried that the new system will not suit a lot of
people and many of them may not realise that they should opt out.
The main problem is the low level of contributions into the scheme. The National Association of Pension Funds estimates that the contributions being made by employers into the NPSS will be half as big as the contributions they make into similar schemes now. The low contributions mean that people in the NPSS will have smaller pensions than those being earned by people in existing schemes. There is also a danger that some employers will cut their contributions by closing down their existing pension scheme and moving to the NPSS. For some people the pension will be so small it may not worth saving for at all.
Means-tests
At the moment up to half of all pensioners can get pension credit – a
means-tested top up to the state pension. Even after all the reforms, the
Government estimates that around one in three pensioners will still be eligible
for pension credit. For every pound of extra income they will lose at least 40p
of their pension credit leaving them just 60p better off. Almost all those who
can get pension credit can also get money off their council tax through another
means-tested payment called council tax benefit. Losing that as well as pension
credit will mean that for each extra £1 from their NPSS pension they will be
just 48p better off. Taking account of the employer’s contribution and the tax
relief the detailed calculations show that for every pound people put in they
will get back just 98p if they are on pension credit. Pensioners not on pension
credit will do rather better getting £1.60 for each pound they put in.
Analysis by the Pensions Policy Institute shows that some people would be better off not paying into the NPSS. People in their fifties are at particular risk of finding that saving in the NPSS is not a good idea. Anyone over 50 who expects to have a limited income in retirement and does not live with a partner who is better off may find that saving in the NPSS is not worthwhile. The Institute says that anyone who will be a tenant rather than a homeowner in retirement should almost certainly not stay in the NSS. They could also lose means-tested help with their rent as well as losing some pension credit and council tax benefit and would end up no better off. Currently about a third of pensioners are tenants though the proportion may be smaller in future. Anyone with big debts on credit cards or loans should use any spare money to pay off their debt before they start saving, even in a pension.
The Government recognises that some people should not stay in the NPSS and it is planning to provide information to help them understand the choices and work out what is best for them.
You can download the new plans Personal Accounts – a new way to save at www.dwp.gov.uk/pensionsreform and comment on them until 20 March. A Bill is expected in the next session of Parliament.
March 2007