It is not just very low earners who face an uphill struggle getting out of the means-testing quagmire and seeing something of value for their saving. Even somebody on £25,000 a year, which is more than the average UK wage of £23,700, will only increase their income in retirement from 30 to 31 per cent of salary after 10 years in personal accounts.
For anyone in their 40s or 50s considering whether to stay auto-enrolled come 2012, it does not look an exciting prospect.
The effect of means-testing on pension savers is a well-worn story but what is so compelling about these figures is that they constitute the first occasion when the DWP has given its own version of how well employees will or will not do through personal accounts.
The figures are published in a written answer to a question posed in the House of Lords by Baroness Hollis. She spent eight years inside the DWP before moving on after a reshuffle in 2005 and has since been challenging the Government in the upper house on a number of pension issues, notably in relation to women. The question she asked was what increase in income a 22-year-old with full basic state pension and a certain level of state second pension will see after 10, 20, 30 and 40 years saving in personal accounts.
Saving for shorter periods not surprisingly brings the least benefits for those on smaller incomes but the dismal return of an extra £2 a week for someone on £10,000 in personal accounts for 10 years is not all down to means-testing. The figures suppose a 4 per cent savings rate phased in over three years, so the policyholder is only saving 1 per cent in year one. Furthermore, because the first £5,035 is disregarded, even the full 4 per cent contribution is pretty small.
For someone in this position, it will be worth staying in personal accounts and saving up to the trivial commutation limit and then taking the cash. Beyond that, such a poor return will make it easy for employees to justify opting out and taking the cash in their pay packet instead.
It is worth pointing out that for many of today’s 40 and 50-year-olds, income will be even less because they may not have so much BSP and S2P as Hollis’s hypothetical 22-year-old. This is because changes to make the accrual of benefits easier will come in too late to benefit them hugely.
The DWP’s statement is not all bad. It does show how the changes to BSP and S2P, combined with several decades of accrual in personal accounts, will help our hypothetical 22-year-old. If he is earning £25,000, then after 40 years in the system he will retire on 48 per cent of earnings, a replacement rate that many people would jump at today. If he opted out of personal accounts, he would be on 35 per cent of earnings in retirement, so staying in will have made a significant difference. Even the worker on £10,000 will see retirement income rise from 84 to 92 per cent of earnings after 40 years.
The Government has got a tricky job squaring the circle when it comes to resolving the lamentable state of pension saving that exists for millions of our citizens. Its reforms will create a foundation for reasonable retirement incomes for today’s young people, if technical issues can be overcome.
For anyone over 45 who has no pension to date, questions remain as to whether it is worth while. For that reason, an increase in the trivial commutation figure or ring-fencing of personal account savings for benefit purposes should be given consideration.
Baroness Hollis should be thanked for bringing the Government’s version of the matter out into the open. Politicians should now start looking at solutions to make the changes fair to all generations.
John Greenwood is editor of Corporate Adviser
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