Scotsman article: Soapbox: Pensions rules are set to punish those who actually save

31 June 2009

IN AN attempt to encourage more people to save for retirement, the government is to compel all employers to enrol employees automatically into a workplace pension from April 2012.

Companies will have to pay a minimum amount into the personal accounts scheme on behalf of staff and employees will also have to contribute.

The minimum level of contributions will eventually be 8 per cent of qualifying earnings, made up of 3 percent from the company and 5 per cent from the employee.

But employees will not be compelled to remain in the scheme. Those who elect to leave will lose their employer's contribution, but many will be prepared to forego this benefit if it means they themselves do not have to tie up 5 per cent of their gross pay.

Controversially, means-tested benefits, especially pension credit, will mean that many workers would arguably be well advised to opt out of the scheme. Pension Credit guarantees everyone aged 60 and over an income of at least £130 a week (£198.45 for couples). Existing pension income is taken into account, although some compensation is given to those who have private pension income.

The problem is that this compensation will be insufficient incentive to encourage those (who are otherwise likely to have no private retirement income) to save in a pension. For example, a couple (both 65) whose only income (from their state pensions) amounts to £140 per week would receive a pension credit of £58.45 a week, taking their weekly income up to the minimum of £198.45.

Now, if the couple also had private pension income of £30 a week, the pension credit award would be £38.41 – giving them total weekly income of £208.41. So despite having a £30 a week private pension, they would be just £10 a week better off than if they had made no private pension provision. These figures were obtained directly from the government's website, www.thepensionservice.gov.uk.

However, this is only half the picture. Consider also the fact that the £30 a week pension might require a pension fund of around £45,000 (assuming the pension was index-linked and included a 50 per cent widows provision). So, in return for building up a retirement fund of £45,000 the couple in our example will be just £10 a week better off than their counterparts who had (for whatever reason) not saved.

Those of limited means who are aware of this anomaly will surely be inclined to opt out of the new scheme.

So, what's the answer? Here are some of the options:

Increase the basic state pension to a level that would eradicate the need for means-tested social security benefits. This would be hugely expensive
Make pensions saving more attractive by, for instance, allowing access to a greater proportion of the fund as a tax-free lump sum, or by making an initial element of income from pensions tax-free, or by allowing lump-sum death benefits to continue beyond age 75.
Make continued membership of workplace schemes compulsory for all of those in work (whether employed or self-employed).

While the third option would be hugely unpopular with many voters, this is the nettle that should be grasped by those in power if our nation's increasing longevity and financial recalcitrance are to be effectively met.

Paul Lothian is a director of Verus Chartered Financial Planners in Dundee.

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