Early Retirement Out of the Window?
John Davies weighs up the recent Green Paper on pensions.
The Government’s long-awaited green paper on the future of pensions was published shortly before Christmas. It puts forward a wide range of proposals designed to tackle what is increasingly being seen as a crisis in UK pensions. These proposals are now out for consultation until 28 March 2003.
The UK had for many years been considered to be far better positioned to cope with the demands of an ageing population than other, more state-dependent countries. Governments in Germany and Italy, for example, where the retired population is forecast to double between 2000 and 2025, have already faced huge political difficulties when trying to reform their generous state pension systems. Spain has even bigger problems – by 2050 it is forecast that there will be no fewer than three people over 65 to every four people of working age.
However, the UK’s relatively favourable position has suffered substantial erosion since 1997. In his first Budget in the autumn of that year, Chancellor Gordon Brown decided to withdraw the dividend tax credit allowed to pension schemes, a move calculated to raise £5bn a year for the Treasury. While this move might have made sense at the time, when many pension schemes were in surplus, its logic has since proved questionable as so many schemes have moved from surplus to serious deficit.
Poor Performance of Pension Funds
Watson Wyatt now report that the stock market slump, which has continued for
three successive years, has left pension schemes with a collective deficit of
£70bn. Another consultant in the field, Russell/Mellon CAPS, reports that
the period 1998 – 2001 has seen pension funds performing at their worst
level since the mid-1970s.
The financial pressures involved with running schemes, exacerbated by concerns about regulatory burdens and the impact of the accounting standard FRS17, have led more and more employers to question their commitment to running pension schemes. This is particularly so with respect to final salary schemes – the National Association of Pension Funds reports that such schemes were being wound up in 2002 at twice the rate of the previous year.
The Green Paper
The Green Paper does not contain any of the more radical ideas which had been
floated in the press prior to publication. For example, tax relief on contributions
and the tax-free nature of the lump sum benefit will both remain. Neither is
there any commitment to compulsory pension contributions on the part of employers,
although this may yet come along in the future – a new body is being set
up to keep the matter of compulsion under review and to advise the Government
on the issue.
The Paper does put forward a number of constructive and sensible proposals which are likely to meet with broad approval and to be brought into effect in due course. They include the following:
- flexible retirement rules will be introduced to enable individuals who have reached retirement or early retirement age to continue to work for the sponsoring employer while drawing their pension entitlements
- those who wish to defer drawing their state pension will be rewarded by either an increased pension or a lump sum payment
- there will be a new protection for members whose schemes are wound up
- employees will have to be consulted on changes to their employer’s pension scheme
- the eight different tax regimes for pension products will be rationalised into one while the administrative burdens on employers will also be reduced
- the Minimum Funding Requirement, introduced following the Maxwell scandal, will be replaced with a scheme-specific funding standard which corresponds better to the circumstances of individual schemes.
On the negative side, there is no commitment to any radical action to address the UK’s restrictive rules on compulsory annuity purchase. Neither is there any commitment to restoring the tax advantages enjoyed by pension schemes before 1997 or to offer meaningful incentives to individuals, particularly lower-earners, to invest in pension saving.
The overriding need in the present exercise is for the Government to produce a long term plan of action which will demonstrate to people that saving during their working lives is likely to result in a materially better retirement income for themselves and their families than would be available to them from relying solely on the State. This must involve providing real support through the tax system to help schemes to grow over time; it must also free those with money purchase plans to make more of their own decisions about how to invest their funds and to draw income from them.
There is certainly a place for many of the marketing and presentational ideas contained in the Green Paper. But the failure of the Government’s stakeholder pension to reach its intended market shows that if the product fails to convince that it can produce the goods, then no amount of tinkering at the periphery will encourage people to invest in it.
John Davies – Head of Business Law, ACCA