The Heritage Foundation senior research fellow David John, speaking to Money Marketing while in London for Friends Provident’s global forum conference, says: “The UK is much more of a welfare state than the US. It already has in place a more complete system from A to Z while ours tends to be some- what more spotty.
“With your personal accounts system, it looks like you are in a position to create a much more universal retirement and sav- ings plan without the mistakes that were in the original state earnings-related pension scheme. It is structured in a way that will probably be difficult to start with but in the long run it looks like something that should pay very significant benefits.”
However, John highlights a number of errors made by the UK Government in the past which have provided the US with some lessons.
He says: “The UK Government has made some significant mistakes that we are going to learn from and the UK seems to have learned from them too. Mistake one was to link the basic state pension to prices instead of wages. Of course, what has happened is that as a proportion of pre-retirement income, it has become substantially lower. That was something that we avoided.
“What is now the state second pension was very poorly developed initially. Evidently, the original actuarial forecasts were not accurate and it has been changed far too many times since.”
John says the UK Government is “further along the way” in reforming its pension system but the US has proposed legislation for an auto-enrolment scheme within its 401(k) plan, a type of tax-qualified deferred compensation plan.
The scheme is called an automatic individual retirement account and has been developed by John and fellow academic Mark Iwry from the Brookings Institution over the last four years. It enables employees to contribute directly into a low-cost retirement savings account with a pre-set contribution rate and diversified investment portfolio. But the scheme does not allow for employer contributions.
John says: “Both Obama and John McCain endorsed the campaign and I am now advising Obama on retirement savings and pensions. The Obama administration will probably have its own ideas on how it will be implemented.”
However, John flags up the default contribution rate to auto-enrolment schemes as a feature that both the US and UK should consider carefully. The automatic IRA is based on a 3 per cent default contribution which the employee can amend later.
He says: “The UK is going to start with a 3 per cent contribution rate, increasing to 8 per cent over time. We have learned that when people start at that level, they stay at the at the same level so there needs to be a mechanism so that once people are in the scheme, their contributions gradually increase. That is going to be crucial.”
He also highlights the importance of the way that auto-enrolment interacts with means-tested benefits. The US does not have means-tested benefits like the UK but it has a benefit based on lifetime work history and lifetime income.
John says: “In the UK, you have a mixture of both. You have some benefits which seem to be very freely given but then on the other hand you have a basic state pension, which is based on a work history that might have made sense in 1935 and would have been onerous even then, given the number of years necessary to qualify for a full pension. It is crucial that auto-enrolment works alongside this.”
Personal accounts have brought a mixed reaction but John says the UK Government should be applauded for placing ret- irement high on its agenda. He says: “The UK has identified this issue early on and has kept the topic going and it deserves a lot of credit for that.”
Rather than posing a threat to existing pension providers, John argues that personal accounts will offer “tremendous opportunities” for providers to reach new groups of people and create products that supplement or improve upon personal accounts.
He says the role of the adviser will be critical. “Even if you have a sales system helping to increase the number of people buying products, as more people become engaged in financial matters, the more they are going to realise that they need better and more individualised advice.”
Speaking of the political challenges facing the UK and US as a result of the recession and financial crisis, John says Obama has much more leverage than Gordon Brown.
He comments: “Both are dealing with economies in a less than perfect situation but Obama came in with a much greater popularity. People like him, even though they might have serious questions over Democratic policies, they will give him the benefit of the doubt. Brown’s honey-moon period was over almost before it had begun.”