The Government should automatically enrol all public sector workers into Nest by 2020 as part of a radical shift to “pure” defined-contribution pension provision, according to the Centre for Policy Studies.
CPS research fellow Michael Johnson’s report on public sector pensions, published last week, outlines a “cautious” reform scenario where unfunded career-average defined-benefit provision up to a salary cap of around £38,000 is topped up with compulsory Nest contributions for people earning more than £10,000 per year, plus a notional DC scheme based on pensionable earnings.
Under his “brave” scenario, the Government would move to completely DC funded provision using Nest.
Under notional DC, schemes, members and their employers pay contributions calculated on pensionable earnings, which are then put into personal accounts. This money is not exposed to financial markets and is direc- ted to independently managed funds separate from general public funds and budgets. These funds are then drawn on to provide benefits for current pensioners. At retirement, money is taken out of the pot and used to buy an annuity.
Johnson suggests introducing limited “seeding” of unfun- ded public sector schemes with tradable Treasury-issued securities to aid a transition towards funded status. This would mean the obligation to pay pension liabilities would be replaced with Government debt. He says: “If you are going to offer anything to higher-earners, and you don’t have to, then it should be notional DC. It has to be notional, or unfunded, because, currently, virtually the whole framework is unfunded.
“If we, in addition to Nest, do anything more in the first 10 or so years, the cashflow pressure on Treasury is going to be too great. The inevitable pro- blem of moving to a funded world is that the Treasury’s cashflow suffers because it is not getting the contributions.”
However, Johnson says brave policymakers would set out a “roadmap” to full DC provision, with the cautious approach used as an interim step. He says Nest compulsion would remain in place under this model.
Johnson also urges the Government to consider absorbing the 1.8 per cent contribution charge at a cost of £64m per year.
Hargreaves Lansdown pensions analyst Laith Khalaf says: “Seeding would increase transparency because it would make the amount the Government owes explicit but I doubt that the policymakers would welcome the idea of adding to their immediate deficit.”
In addition, Johnson calls for an overhaul of the structure of funded local government pension schemes, with “complex and ineffective” local funds replaced by a single, trust-based board. He also wants to see the implementation of “total reward” in benefit communications to improve employee apprec- iation of the value of guaran- teed pension benefits.
Johnson suggests policymakers should “prepare the ground” for reform through the introduction of a flat-rate basic state pension. A DWP green paper proposing a single, universal benefit for future retirees, due last year, has yet to materialise.
The paper highlights the fact that one actuarial consultancy believes when the Principal Civil Service Pension Scheme moved from final-salary benefits for new joiners to career-average benefits in 2007, this may have actually increased the taxpayers burden of the scheme.
Johnson’s paper has been backed by Lord Blackwell and Baroness Hollis of Heigham. In a foreword to the report, they say: “As an essential starting point, Johnson makes a powerful case for ensuring all citizens, whether employed in the private or public sectors, have the bedrock assurance of an adequate basic state pension. They would then be better positioned to build additional retirement income through a combination of Nest, other pension plans and private savings.”
Johnson’s previous publications include, Don’t Let This Crisis Go to Waste: A Simple and Affordable Way of Increasing Retirement Income; and Simplification is the Key: Stimulating and Unlocking Long-term savings’.
The latter report, which was also backed by Hollis and Blackwell, put forward a number of radical pension tax simplification proposals, including setting an annual contribution limit of £45,000 a year for all tax-incentivised savings and introducing fluidity between Isa and pension savings.
’Sustainability is the key’ – policy recommendations
- Compulsory Nest participation for public sector employees earning more than £10,000
- The state should absorb the 1.8 per cent Nest contribution charge
- Government should only use a switch to career-average DB provision as an interim step to full DC
- Limited seeding of unfunded public sector schemes with Treasury-issued gilts, effectively turning pension obligations into immediate Government debt
- Replace ’complex and ineffective’ local government pension scheme governance framework with a single, trust-based board