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The 2008 Pensions Act

Public Sector Pension Reforms

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A Budget for "makers, doers and savers"

New Labour's real legacy

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Pensions

The Pensions Damp Squib

Can you hear it ticking, you know the 'pensions time bomb', probably not, because its only a metaphor. However, Britain could face a £800bn pensions shock by 2050 as a result of its ageing population, the International Monetary Fund (IMF) has warned.

On hearing this news, Captain Dave, when he was the nation's leader, said he had a plan for this problem... everyone must work longer and contribute more to their pension pots and they must be satisfied to get less at the end of the day.

And yes, they must trust the financial markets, the pensions peddlers, the regulators, the trustees, the employers, the politicians and everyone else that has betrayed workers' pension prospects over the past decades.

The government's position on public sector pensions runs as follows: reform is necessary, public sector pensions are unaffordable and it's only fair to take action for all tax payers, who pay for the public sector pensions.

State Pensions Changes: The 2008 Pensions Act

The Plan is to increase the state pension age to 66 by 2026, rising further to 67 by 2036 and 68 by 2046. Dave wants to accelerate the rise in the state pension age to 66 by 2020, and it also proposing to accelerate the equalisation of state pension ages to 65 by 2018. A more automatic mechanism for reviewing state pension ages has been proposed for the future. Underpinning these changes is the simple idea that says, we are all living longer therefore we should all work longer as well. So, within the next 40 years Britain will be virtually back in the same position it was in 1908, when Lloyd George introduced a means tested state pension of 50p a week for those of 'good character', at age 70.

Public Sector Pension Reforms

The Coalition Government convinced the world that public sector pensions must be reformed, they are simply unaffordable and unfair.

Government spokesman, e.g. Treasury Minister Justine Greening, Cabinet Office Minister Francis Maude, George Osborne and the Prime Minister all spoke on the need for pensions reform. Typically, they said that future workers must not be made to suffer for lack of action now, the impression is generally given that pension spending is out of control.

Conveniently, these people failed to acknowledge the reforms put in place by New Labour. This is odd, when you consider that those reforms appear in a Public Accounts Committee (PAC) report, appropriately titled: The impact of the 2007–08 changes to public service pensions.


So to be precise, what those ministers, proposing big pension changes to save a future generation actually meant was, 'further reform of pensions was needed'.

Affordability

What's the evidence on affordability, are costs rising, is the situation out of control? No government department has, as yet, supplied a benchmark or measure of affordability. We shall see that expert opinion on the future cost of pensions is in broad agreement but it's all guesswork.

The pensions cost equation includes the following variables: the ratio of workers to retired people, life expectancy, the retirement age, saving more and paying more tax, the size of the public sector workforce, earnings growth, and the discount rates used in projections. So, as I said, there's a lot of guesswork involved in working out the cost of future pensions.

"Officials appeared to define affordability on the basis of public perception rather than judgment on the cost in relation to either GDP or total public spending." PAC (1)

Over the next fifty years or so the Government Actuary Department, 2009, suggests that as a share of GDP taken by public service pensions will be flat or will fall slightly.

The Office for Budget Responsibility, the OBR, did their own sums and suggested the following: 1.77 per cent of GDP in 2010-11 to 1.76 per cent in 2015 and from then on the pensions share 'would remain broadly flat'. The National Audit Office (NAO) also supported these findings.
However, the NAO was shy about discussing affordability:

"We do not comment on whether public service pension schemes are financially affordable because that is a political judgment rather than an audit assessment."

"Government projections suggest that the 2007-08 changes are likely to reduce costs to taxpayers of the pension schemes by £67 billion over 50 years, with costs stabilising at around 1% of Gross Domestic Product (GDP) or 2% of public expenditure." (1)

Public Sector Pension: Changes made in 2007 and 2008

Three main changes were made. First, the age at which a scheme member could draw a full pension was increased from 60 to 65 years for new members. Second, employee contributions were increased by 0.4% of pay for teachers and by up to 2.5% of pay for NHS staff. Third, a new cost sharing and capping mechanism was introduced to transfer, from employers to employees, extra costs that arise if pensioners live longer than previously expected. The so-called 'cap and share' part of this agreement is a trifle vague and will probably require a whole new government department to work out the details.

So far we know that pension costs are not set to rise over the next 50 years, we know that the changes put in place by New Labour in 2010 would have gone some way to holding down pension costs but we don't know if pensions are affordable because that's a matter of opinion.

The inflation calculus

The Coalition Government also announced additional changes to pension calculations in 2010, which included indexing pensions to the Consumer Prices Index rather than the Retail Prices Index, which will reduce costs further.


Also Hutton has suggested a move from final salary to career average pensions - KPMG say this will lead to lower returns. It would be much better to describe career average schemes as undefined benefit schemes. That is because it is very hard indeed for anyone to calculate in advance how much pension will be generated for them on retirement.

Fairness and the “race to the bottom”

Public sector pensions have long been out of sync with the private sector or so the Government argues therefore it is only “fair” to redress the balance. All utterances about fairness are combined with some nonsense about 'gold plated' public sector pensions. The Hutton Commission is clear on one point:
“The Commission firmly rejected the claim that current public service pensions are ‘gold plated’.”
The figures bear him out. In the big four national schemes the majority of pensions paid are less than £5,600 a year. In the Local Government Scheme half get less than £3,000.

Of course a few very well-paid public servants get considerably more than this. But there are not many of them. And unlike the private sector, where top boardroom pensions are solid gold, many top public servants are in the same scheme as their staff.

The Pensions Policy Institute tells us:

"There's not much of a difference between defined benefit schemes in the private sector and defined benefit schemes in the public sector now. The difference is that in the private sector people have moved away from defined benefit to defined contribution. People in the public sector still have access to schemes that people don't get in the private sector. The private sector has changed and the public sector hasn't. "

Another thing that's changed is comparative wages between the two sectors. Historically, wages were lower in the public sector and higher pensions were seen as a reward for earning less. However, wages in both sectors are broadly the same, where it is possible to compare like for like work.
The TUC's position is that the government has fired the starting pistol on a race to the bottom and will not be happy until public sector pensions are as abysmal as those in the private sector, that is, for the workers.

Beyond the soundbites

Public sector pensions currently cost the taxpayer £32bn a year. The affordability of this number is simply a matter of opinion.
Talk of fairness is a red herring, median and mean average pensions in the public and private sector are broadly similar, according to the National Association of Pension Funds (NAPF). The NAPF, recently reported that millions of private sector workers faced a "bleak old age" because they fell through the cracks of pension provision. Hence the average does not include all those people who are not paying towards a pension.
Also, those who talk of fairness are not keen to talk about the costs of pension tax relief, currently running at £35 billion a year – more than the cost of public sector pensions and heavily skewed towards the rich.

Questions of inter-generational equity will not be solved by bringing down public sector pension payouts. Equity like affordability is about choices. The idea of workers paying more for a pension throughout a lifetime of work and working longer to receive less at retirement is not equitable.


Rather than some egalitarian notions about future generations, the government's time would be better spent on fixing the lottery of annuities, excessive charges, and the typically poor returns for lower earners in private pension funds. (This point was made before Boy George announced changes to the situation concerning the need to buy an annuity. George’s slight of hand on this issue is discussed in full below.)

National-Employment-Savings-Trust-NEST

Employers today are under no obligation to contribute to an employees' pension scheme. Firms employing five or more have to offer them access to a no-frills stakeholder pension, but they don't have to pay anything in. The introduction of Nest will see all employees automatically enrolled in a pension scheme into which they, and their employer and government, pays.

Workers will be automatically enrolled if they earn more than £7,475 a year and have been with the company for three months. If they earn less than £7,475, are under 22, or are older than the state pension age will not be automatically enrolled - but you can choose to.
Every company in the country will be forced to enrol its employees in a pension. This new scheme, which begins in October 2012, is called the National Employment Savings Trust, or Nest for short.

Until 2016 the total annual contribution will be at least 2% of an employee's earnings above £5,715, of which the employer pays in 1%. From October 2016 to September 2017, total contributions will be 5% - with employers putting in at least 2%. And from October 2018 contributions will be 8%, with employers putting in at least 3%, employees 4% and 1% coming from government tax relief.

The Nest scheme could lead to companies reducing their contribution, i.e. offering Nest in place of existing arrangements.This scheme will be costly for businesses. There are 800,000 businesses with fewer than five employees and 192,000 with just one. It could mean some companies stop taking on staff.

Once the scheme is up and running, someone who earns £25,000 would get a pension of £7,000 a year if he or she worked for 30 years, and £2,000 for 15 years.

"Auto-enrolment will help, but it's a halfway point, not the final answer. More needs to be done. We hope this report will be a catalyst for discussion about the bigger picture. There's no point bringing people into pensions that will erode their savings through high fees.The Government should set a clear ceiling on the charges that will be allowed under auto-enrolment." (Mcfall Report, Aug 2011)
McFall also stated that annuities stand out as 'an area sorely in need of a shake-up. People are being shortchanged by the current system, and it's unfair that a miscalculation can haunt them financially for decades.'

Ah, but, contributions to the Government's National Employment Savings Trust will be capped at £4,200 a year. Anyone wanting to pay more would have to go to private funds which can set their own fees and leave workers open to mis-selling. There is also a question mark over who pays the cost of setting up the Nest scheme, will early recruits be unfairly penalised by paying higher charges than later recruits, once the scheme is firmly established?

Private pensions: The Current Picture

The number of employees in private sector workplace pension schemes has fallen by over a quarter since 2004. Most private sector workers are not currently saving in a workplace pension.
Most private sector defined benefit (DB) schemes are closed to new members and many are closing to existing members. Private sector workplace pensions are now
mainly defined contribution (DC).
Annuity rates continue to fall, as life expectancy increases, but also because interest rates remain low. Investment returns have been unusually low with consequences for the actual and perceived value of pension saving. (1. From McFall, p.13)

Overall numbers saving into a pension
In 2009/10 only 36% (14.0 million) of those aged 16‐64 were actively contributing into a private pension (whether a workplace or their own private pension scheme).

Over the previous decade, the proportion of men saving into a pension fell from 49% to 38%, whilst for women it fell from 36% to 33%. (ONS)
The active membership of public sector schemes is stable at 5.4 million but the number of employees contributing to private sector schemes fell by 300,000, to 3.3 million. Taking into account pensioners and deferred pensioners - people who have left employment but not yet drawn their pensions - 27.7 million people had a direct stake in an employer's pension scheme last year, the same as in 2008. (ONS)
The key feature of the pensions landscape in recent years is the disappearance of Defined Benefit schemes, the stage of this shift saw these schemes being closed to new members and, more recently, closing the schemes completely, offering Defined Contribution schemes in their place.

A Budget for "makers, doers and savers"

Beyond the IMF's silly talk about Britain's amazing recovery, Maria Miller was distracting the populace from Boy George's epoch making 2014 budget. The piece de resistance of George's economic package for the future was removing the necessity for those on defined contribution pensions to buy an annuity.

Silly pensions minister Steve Webb said:

"If people do buy a Lamborghini but know that they'll end up just living on the state pension, that becomes their choice"

There you have it, enabling people to be free to choose how they spend their nest egg. It apparently is not the job of government to advise people on how to spend their savings. That's a new turn of events, after decades of forcing people to buy annuities. The government would, however, be providing free advice on how people might spend their savings. Boy George said he didn't believe that people would 'blow' their pensions by buying fast cars. Just as well really since a Lamborghini would set you back £160,000. The average pension pot will be in the region of £25,000. Worryingly, the Financial Conduct Authority (FCA) reviewed 25 pensions firms representing 98% of the UK annuities market, the typical pension savings analysed in their review was £17,700. The FCA also noted that the annuities industry was not interested in citizens with tiny pension pots.

However, what really lays behind George's abandonment of annuities? We know that returns from annuities have been low and getting lower over the last 15 years or so. Indeed returns on annuities under the current regime have left many on severely reduced retirement incomes due to their do nothing low interest rate policy. We do know that they will be salivating over the prospect of a tax grab if citizens do decide to extract taxable lump sums from their pension pots. Although, the government will be unable to predict whether this tax grab will fund high speed rail links to the wastelands of the North.

We may wonder though, is George's ingenious scheme less to do with providing choice and more to do with covering up for the historic failure of pensions industry and the current policy failings of the government. Last year when the government introduced its auto-enrolment pensions scheme to encourage everyone to save for retirement, mainly people on low pay. Expert commentators on George's annuity policy have focussed on people buying cars and holidays, the government's short term tax grab and the effects on the housing market, as retirees' opt into the buy-to-let market as a means of funding their retirement. All very interesting but most of the pension pots under consideration will not be big enough to put down a deposit on a house, let alone buy one.

Let's be clear, the people with the calculators, who tell George what to say, have sat down with the pensions industry and worked out that future pension pots arising from the drones signed up via auto-enrolment may only be sufficient to cover a decent send off. Put otherwise, the industry cannot provide any financial guarantees via annuities for people with minuscule pension pots, so to save the government the embarrassment of acknowledging that its flag ship pension scheme is pretty pointless, better to make savers believe they are being given a choice, when in reality no choice will be provided by the pensions industry.

New Labour's real legacy: the destruction of the pensions industry.

In the late eighties the Tories introduced personal pensions, enabling members of occupational pension schemes to transfer the benefits they had already built up into these brand new sparkly schemes - all part of the wider government drive to spread the personal ownership of assets. This was the beginning of the end of defined benefit schemes.

Commission hungry salesmen promoted the idea by saying that employees' pensions would grow at a faster rate in personal pensions, conveniently forgetting to mention the enormous charges that completely eroded any growth the pension funds might achieve and the very important fact that in most cases employers would not contribute to personal pensions.
The regulator began a review of pension sales in 1994 in response to consumer complaints about mis-selling, and by 2002 insurance companies and financial advisers were forced to pay £11.8bn in compensation to more than one million customers for incorrectly advising them to leave or not join their employer's scheme.

We can put these pension peddlers in the same category as America's hot dog vendors, selling sub-prime mortgages, unconcerned about consequences and driven by commissions.

However, the death of defined benefit schemes came in an instant, in a foolhardy act of vandalism. Gordon Brown's abolition of tax relief on pension funds' investment dividends was far more criminal than the earlier mis-selling, his action managed to destroy one of Britain's few success stories. Brown's theft netted the treasury £5bn annually, everyone else involved, i.e. the victims of the crime lost out. Brown's action was inspired by the belief that companies were choosing to pay dividends in place of investing in order to gain the tax relief.

As a direct consequence of Brown's action, employers started closing defined benefit (DB) schemes, offering defined contribution schemes in their place, and then closing DB schemes to existing members - leaving millions of pensioners poorer in their last years as returns on shares and gilts felt the impact, annuity rates fell. This one act destroyed the pensions industry. Brown's crime is made worse when we learn that he ignored four investigations undertaken by the Treasury, at his request, to look into the impact on pensions industry of his proposed tax grab: all reports were negative, Brown ignored them all. (2) And to this day, Brown's gollum, Ed Balls, continues to deny the damage done and claims that civil servants backed the tax grab and it did what it was intended to do, boost business investment.

Sources:
1. 'Building a strong, stable and transparent pensions system 'Workplace Retirement Income Commission, McFall Report Aug. 2011)
2. The Great Pensions Robbery, Alex Brummer, 2010