Cicero Policy Briefer

Issue 21, February 2008

Will the Government’s pension reforms deliver?

By Niki Cleal, Director, Pensions Policy Institute

The Government has set out a wide-ranging package of reforms for both state and private pensions. The question is: will these reforms deliver? The Pensions Policy Institute, an independent research institute, has analysed the impact that the Government’s reforms are likely to have and identifies the challenges for the Government as the Pensions Bill makes its way through Parliament.

The Government plans to introduce a far-reaching set of pension reforms to encourage more people to save for their retirement. These reforms are set out in the current Pensions Bill that is before Parliament. If enacted, the bill will require all employers to automatically enrol their employees into a personal account or into an existing good pension scheme. Employees will contribute 4% of a band of their earnings and, unless the employee opts out, employers will be compelled to contribute a minimum of 3%. The Government will contribute at least a further 1% in the form of tax relief. So how likely is the Government to get the Pensions Bill through Parliament?

The Government’s proposals largely conform to the template set out by the Pensions Commission and have commanded a fairly wide degree of consensus. Employer bodies, unions, consumer groups and the main opposition parties have stood behind the broad framework of the reforms. These organisations recognise that something needs to be done to encourage more people to save for their retirement. However, the debate in Parliament in recent weeks has revealed that, while there may be broad agreement on the general principle and direction of the reforms, there are significant concerns and differences of opinion about how workable the Government’s reforms really are and what overall impact they might have.

Two major concerns have been expressed: whether it will pay for people to save in a pension due to the interaction of the new system with means-tested benefits; and the possible negative impact that auto-enrolment could have on the existing pension market. This is often referred to as the risk of “levelling-down”. Views differ as to the significance of these two issues. The Government generally takes a more sanguine view than the opposition parties or the pensions industry.

PPI research suggests that there are concerns about the extent to which it will pay to save for certain groups of people. However, it is important not to overstate the problem. Many people could benefit from the reforms – particularly younger workers who currently work for employers that do not currently contribute to pensions. But there are some people for whom the returns from saving may be undermined by the interaction with means-tested benefits, such as those who rent in retirement and some older workers who are low earners and have limited additional saving.

The Conservatives and the Liberal Democrats are calling for the Government to address the problem. So what could the Government do?

The Government’s answer thus far is generic advice. The Thoresen Review is due to report later this year on a blueprint for a national system of generic advice. While this is undoubtedly welcome, there are other policy options that the Government could consider. It could disregard some pension income in calculating people’s entitlement to means-tested benefits. It could increase the amount that people can take as a lump sum. Both of these reforms would have an associated cost to the exchequer. The PPI estimates the cost to be at least £500m per annum in 2012. But there is also a cost to the Government of not addressing the means-testing issue - the risk of not getting the reforms through Parliament, or undermining the success of the reforms in the long term, and that would be a missed opportunity indeed.

Niki Cleal is the Director of the Pensions Policy Institute and can be contacted here.

Disclaimer: This article is intended as a contribution to the policy debate on personal accounts. It should not be relied on by individuals or their advisers as the basis for saving and investment decisions.