The process of automatically enrolling staff into pension schemes began this week. Will the strategy be hailed a success and provide enough money to employees when they retire?
For far too long the UK has been able to get away with one of the least generous state pension schemes in Europe.
One of the reasons for this was the substantial defined benefit pensions available in the private sector that provided the cake for pensioners, against which the state pension was merely a top up, the icing on the cake.
The demise of defined benefit pension
schemes in the UK and their replacement by far less generous defined contribution arrangements have brought the inadequate state pension system into the limelight. The cake has disappeared and pensioners have no hope of adequately surviving on the icing.
That is why the roll out of automatic enrolment which began this week is so important to the future well-being of pensioners and the public purse in the UK.
Large numbers of staff working for the UK’s largest employers and who are not already in a workplace pension scheme will begin to be automatically enrolled into a pension scheme.
Eventually all those who work in the UK, are aged 22 and under state pension age, are not already in a scheme and who earn more than £8,105 per year will be automatically enrolled.
The upbeat approach of the television adverts fronted by a number of 'stars' masked the fact that making automatic enrolment successful will be an uphill struggle. But then those of you who watched the Ryder Cup will know anything is possible.
Minimum contributions from both employers and employees into automatic enrolment schemes start at almost nothing and even by 2018 when they reach the full minimum amount of the equivalent of 8% of a worker's earnings will only see £1,154.88 per year go into the pension pot of a worker earning £20,000 a year.
One of the major problems facing automatic enrolment is that this is simply not enough. A pension pot has to be used to buy an annuity
(pension) in due course and annuity rates are at an all-time low. Workers on £20,000 a year saving for decades are going to be lucky to see £100 a week during retirement.
Moreover reform of the state pension system, and the introduction of a flat-rate pension above the means testing level, is a must unless automatic enrolment is going to snatch defeat from the jaws of victory as the Americans did at the Medinah Country Club.
Unless those workers on £20,000 are going to get some additional pension in return (as opposed to simply having their means-tested benefits reduced) it is not worth them remaining in their automatic enrolment scheme and they will opt out in their droves.
Furthermore if members remain in automatic enrolment schemes only to find they have paid out for nothing on retirement this could end up a pensions mis-selling
scandal on a scale not yet imagined.
The pensions minister must find a way to overcome the doubts of the prime minister with his flagship pensions reform, despite his soon to be published white paper turning in his own words 'minty green', as colleagues start having cold feet.
The success of automatic enrolment is vital to the ever growing number of pensioners in the UK, but let us give it the impetus to succeed by being honest about the scale of contributions that will be needed to make this a success backed with reform of the state system.
Momentum is everything at this time as the Europeans proved in the Ryder Cup. Like Martin Kaymer, the pensions minister must keep his nerve when the pressure is at his highest if glory is to come his way.
Fraser Smart is the managing director of Buck Consultants
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
Defined benefit pension
Often referred to as a “final salary” pension, benefits paid in retirement are known in advance and are “defined” when the employee joins the scheme. Benefits are based on the employee’s salary history and length of service rather than on investment returns. The risk is with the employer because, as long as the employee contributes a fixed percentage of salary every month, all costs of meeting the defined benefits are the responsibility of the employer. (See also Final Salary).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.