Sunday 10 January 2010

NEST - compulsory pension savings for employees

In the UK, many people face an impoverished retirement. Stakeholder Pensions were introduced in 2001 as a simple and cheap form of retirement saving, but even now, nearly 12 million people have no pension plan, or a very small one. There are reasons for this - including being too poor to invest enough to make a worthwhile difference to one's retirement income.

From 2012, this will change. A compulsory scheme will be introduced in workplaces, for people that haven't already joined a scheme. It's been called by different names and has just been rebranded "NEST" - the National Employment Savings Trust. (The logo (see left) reportedly cost £363,000 to dream up - the equivalent of over 100 years' worth of maximum contributions to a NEST plan.)

There was an earlier, and in my view better, scheme mooted by one-man think tank the Rt Hon Frank Field MP, who set up the Pensions Reform Group in 1999 to address the issue. They came up with the idea of a Universal Protected Pension, which has 5 principles:

1. Together with the Basic State Pension, an extra (funded) pension should eventually lift all pensioners permanently above the poverty line, by providing a total minimum income of 25-30% of average earnings. Those who are able and willing, can pay in more to get more.
2. It should be for everybody.
3. It should operate as a redistributive scheme: everybody pays a proportion of their earnings (so higher earners pay more), but everybody will get the same benefits.
4. The layer on top of the Basic State Pension should be funded - i.e. it would become an enormous investment fund. Without this, the whole scheme would be another expensive unfunded Government undertaking and at risk of being cut or abolished when the national budget gets tight.
5. It should be kept independent of the Government, to keep the politicians' hands off it.

Like other ideas by Mr Field, this one has been well thought-out. And like some of his other ideas, it's been ignored, or badly adapted. Perhaps, in this case, it's because politicians understand the temptation of (4) too well to think that (5) would work.

Let's look at (1 - 3) as well. Without compulsion, many workers not only would not join, but might be foolish to join. This is because of the way the benefit system works. If you reach retirement with an income of less than a certain weekly amount, the State will top it up. So if you know that is going to happen, it's not worth saving up out of your earned income - you'll just get less by way of a free top-up, so it's as though your personal provision was being taxed at 100%.

To answer this objection, the State first discounts each pound of income you provided for yourself, then re-awards you a "Savings Credit" of 60p. But this is still, effectively, a "tax rate" of 40% - Higher Rate Tax for the poor. This explains Steve Bee's comment on NEST:

Now all we need is for the government guys to fix things so that the pension savings of low to moderate earners can’t be devalued by the unfortunate way pension savings currently interact with the means-tested entitlements that are provided for the elderly and we’ll be cooking on gas.

Not surprisingly, financial advisers find themselves in a quandary when advising lower-paid people about funding for retirement!

Under Frank Field's group's proposals, there would be no decision to make, since contributions would be compulsory. But also, however little you contributed, you would still attain the overall target income of 25-30% of average earnings and be above the notional poverty line, so the complicated and self-defeating system of Pension Credit and Savings Credit would be redundant.

Instead, the NEST is universal only for those who aren't already in a scheme, and you only get the results of what you and your employer have put in - no redistribution effect. Presumably the employer will take into account what he/she has to contribute to the pension, when calculating what pay rises to give you, so it's not even "free money" from the employer. In effect, we have a variant on the current unsatisfactory system, plus compulsion.

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