Mercer Human Resource Consulting has called for a radical overhaul of the UK pension regime.
It proposes a triple solution: an enhanced but still flat-rate state pension; separate but still tax-privileged private pension; and further private provision through a range of savings types, plus new and flexible rules on retirement ages and lump sum payments.
The first idea would combine the Basic State Pension and State Second Pension into a single flat-rate, integrated pension increased in line with earnings. Contracting out would be abolished and the Minimum Income Guarantee and Pensions Credit scrapped – payable only to those generations now in or near retirement. Mercer has also called on the government to clarify the role of the state and private sectors in providing pensions, and to give employers clear incentives to make retirement provision for employees.
Mercer’s recommendations come as Alan Pickering is due to announce his own recommendations on pension simplification, following his government-sponsored review. Recent reports have indicated that his proposals may fall short of radical reform. Three other reviews have been commissioned by the government covering how trustees invest, how pension schemes are taxed and how insurance companies address long-term savings.
Dr Deborah Cooper, senior consultant and actuary at Mercer Human Resource Consulting commented: “The government has commissioned a series of reviews on pension reform, but none of these appear to address the fundamental issue – that the cost of pension provision is increasing due to lower investment returns and increased longevity. Until the government addresses the basic needs of the population over state pension age, and restores the incentives for long-term saving, pension provision in this country will continue to wither. This country is facing a huge pension challenge with employers blamed for closing defined benefit schemes and insurance companies reproached for the complexity and cost of their products. But this government and its predecessors face the most wide-ranging criticism of all. Successive governments have reduced the incentives that encouraged employers to provide pension schemes, by cutting the contracting-out rebates and removing the dividend tax credits. And by legislating to improve post-retirement and early leavers’ benefits assuming schemes were in surplus, governments have failed to recognise that employers bear the risk of schemes falling into deficit. What we are seeing now is the decline of state and occupational pension provision at a time when the cost of pension provision is reaching historic highs.”
Mercer has criticised the current plethora of state retirement benefits that include the Basic State Pension, SERPS, State Second Pension, Minimum Income Guarantee and Pension Credit. These create confusion and, through their overlap with private sector benefits, impose a heavy burden of administration for employers. Commenting on this, Dr Cooper said: “The new State Second Pension addresses some of the problems of SERPS but at the cost of such complexity that most people will be unable to appreciate the benefits. The Minimum Income Guarantee only meets about 70 per cent of a person’s basic needs in retirement and, furthermore, about half a million eligible pensioners are not drawing this benefit.”
The savings of pensioners who claim the Minimum Income Guarantee are taxed indirectly by up to 100 per cent, and the new Pensions Credit will merely reduce this tax rate to 40 per cent. “Imposing a high marginal rate of tax on people with low incomes creates a serious disincentive to put money into long-term pension saving,” Dr Cooper commented.
Mercer’s proposals rest on securing basic needs through state provision and encouraging people to provide for themselves above this level. “Means testing is not a suitable basis for retirement planning,” said Dr Cooper.
Mercer recommends that a flat-rate state pension of 140 a week should be provided to meet basic needs, and that this should be increased in line with earnings rather than prices as currently. The 140 figure is based on research amongst a number of UK retirement organisations including Help the Aged and Age Concern.
The government could then be less concerned with pension provision above this point, which would be voluntary through private or employer-sponsored saving. Employers’ pension contributions should continue to be exempt from National Insurance (the current exemptions provide a significant subsidy of up to 24 per cent for occupational schemes). Mercer suggests that pension saving could be made much more attractive by extending the exemptions to employees’ contributions.
The cost of providing a more realistic level of state pension could be met through increased National Insurance contributions or by increasing the State Pension Age. “Increased state provision would reduce the cost burden and risk exposure of employers, and could stem the flow of employers abandoning decent occupational pension provision,” said Dr Cooper. “A regulatory regime that allowed for flexible benefit payments and retirement ages would give employers the incentive to meet the needs of a workforce that increasingly will need to work for longer.”
Mercer also advocates a third pillar of retirement provision which employers could support. This could be through share ownership, home ownership or assisted savings, acting as a top up for those on higher incomes or those who need to plug a gap in their retirement savings.
Dr Cooper commented: “People have different abilities to save during a working lifetime, and need flexible vehicles to help top up basic provision. Often a pension is not the solution. The aim is to build up total retirement wealth, and this may come in many forms. Non-pension assets are also more flexible when it comes to meeting ‘lumpy’ outgoings in retirement – be it a good holiday or an unexpected need for private healthcare.”
She concluded: “The government must adjust the tax and savings regimes so that everyone can be confident that their savings are not at the disposal of the Inland Revenue. By creating an effective first pillar of retirement income, the government will build on the best features of state retirement provision. It is hard for the private sector to provide pensions to lower-paid, transient workers efficiently. An integrated state pension would do this well, providing a platform from which nearly everyone could get best value from their savings and have their basic needs secured.”