Question mark over benefits of pensions
Pension experts have criticised the government’s much anticipated review of pension reform for failing to offer conclusive evidence that people who save will be better off in retirement.
The Department for Work and Pensions’ investigation into the effectiveness of the British pensions systems has concluded today that most people will be better off in retirement by saving, with the majority getting back more than double what they save.
Rosie Winterton, minister for pensions and the ageing society, says the review highlights the importance of auto-enrolment in 2012, where people will be opted into a workplace pension.
"Rather than putting your money under a mattress, sensible saving is about making your money work harder for you, whether it is in a pension or in other ways,” she adds.
However, not everyone is convinced by the Department’s findings. For some time there has been widespread concern that means-testing people for the state pension undermines the benefit of saving for retirement.
John Lawson, head of pensions policy at Standard Life, says means-tested benefits are necessary to keep pensioners “above the poverty line”. But he adds: “Continuing to signal that future pensioners will be bailed out in the same way creates moral hazard among today's workers, meaning that many who should save will not.”
Lawson says the government must be clear on whether it plans to scale back means-testing in the future in order to encourage current workers to save for their own future.
The government's report claims that 95% of people will retire with more money than they originally put into their pensions, even after taking inflation into account. However, this still poses the problem of the 5% of people who will be worse off as a result of saving.
Paul Macro, a senior consultant at Watson Wyatt, points out that the 5% figure refers only to people who do not get back the value of the contributions they pay themselves, and does not include people who do not get back the full value of contributions that employers pay on their behalf.
He adds: “From the employee’s point of view, there is always a risk that tying their money up for 30 or 40 years could be a mistake with the benefit of hindsight – for example, if they end up needing the money urgently or if they die before they get the chance to spend it.
"That’s why people expect a good rate of return in exchange for a long-term commitment. After that length of time, few people would think they had done well just to get their money back after the tax and benefits systems have done their work. Is that really rewarding saving?"
The introduction of auto-enrolment in 2012 will see workers automatically opted in to a workplace pension or a new type of retirement vehicle, called Personal Accounts.
The concern is that people might save in a Personal Accounts only to find they are simply replacing means-tested benefits they would have received anyway.
Joanne Segars, chief executive of the National Association of Pension Funds, says: "The research shows that for the majority of people it will pay to save. But there is an important minority for whom this is not the case.
"If Personal Accounts and auto-enrolment are to be successful, the government must work hard between now and the 2012 launch to rebuild confidence in retirement saving. [This includes] identifying those who will not be better off and then providing appropriate advice to them."
Laith Khalaf, pensions analyst at Hargreaves Lansdown, says auto-enrolment and Personal Accounts create a Catch 22 situation. On one hand, auto-enrolment aims to encourage people to save for retirement rather than just rely on government support. However, means-testing could mean saving is pointless for some people.
“Means-testing means there will inevitably be some losers from the introduction of Personal Accounts in 2012, but these are by far the minority,” Khalaf adds. “There would be millions of people reaching retirement with empty pockets if the government had sat on its hands.”
Rachel Vahey, head of pensions development at AEGON, agrees that, on the whole, auto-enrolment will emphasise the important of saving for retirement.
But she adds: “People need to be reassured that saving is the right action to take and that they won't be penalised for it in future.”
Vahey believes the government needs to make sure the benefit system doesn’t undermine saving: “Pension saving needs to be an instinctive positive choice, rather than a decision to be struggled over."
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).