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Decent thoughts

I have spoken at a number of pension seminars this year and have noticed that when other attendees and speakers talk about the 2012 changes, they often say that it will be the first time that every employee in the country will have a decent company pension.

I always find myself wanting to interrupt when I hear such sentiments as there is a world of difference between a “pension” and a “decent pension”.

For those employees whose annual earnings are £10,000-£15,000 (the target market), the first two changes will have a significant impact on their pensions when described in terms of what governments like to call “replacement rates”.

Stopping the basic state pension from losing value compared with average earnings levels every year and making the state second pension more redistributive through the provision of a flat-rate top-up to the basic pension will mean someone earning the equivalent of £10,000 today throughout a working career starting in 2012 will end up with a pension of £8,400 a year in today’s terms. A “replacement rate” of some 84 per cent.

But auto-enrolment into 40 years of savings through, say, the system of personal accounts will only improve that replacement rate by eight percentage points to 92 per cent. An extra £800 a year pension in today’s terms in return for 40 years of persistent saving. It does not seem much but we need to realise that for someone earning just £10,000, over half their earnings will not be pensionable under the terms of this new scheme. So an 8 per cent overall contribution will in practice be just a little less than a 4 per cent contribution compared with their total salary, with the total weekly pension contribution from the employee, the employer and the taxman amounting to something like £7.70.

Years ago, back in the 1940s and 1950s when people were thinking seriously about the post-war demographics and pension saving, the view was that a replacement rate of two-thirds of earnings levels at retirement would represent a “decent” pension. Company pension schemes and government-run pension schemes for public sector workers aimed to achieve this 66 per cent replacement rate and in many cases succeeded in doing so. Back then, it was thought that the pension legislation should cater for the self-employed in the same way that it did for employees and retirement annuity policies (the precursor to today’s personal pensions) were supported by tax legislation aimed at providing a similar replacement rate of 66 per cent.

When judged by outcomes in terms of the replacement rates that the current reforms will achieve, it is likely that those in the target market will see great improvements over time. Not through pension saving as such but through structural changes to the state pension schemes. Those that look most likely to be the losers through these changes are, of course, those who are too rich to be classed as being poor but too poor to be classed as being rich. As usual, those caught in the middle.

Steve Bee is head of pensions strategy at Scottish Life

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