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Pension lessons from abroad

In April, the Association of British Insurers, published a fascinating paper, available on its website, entitled, UK Pension Reform – Lessons From Abroad?

The key is the question mark at the end because the message is that a lot of countries held up as pension paragons have, in fact, quite serious drawbacks when examined more closely.

Take for example the US. For the 43 per cent of the workforce with access to an occupational pension, the system works fine.

However, for those on half of average incomes, it falls some way short of the average for developed countries.

The lessons for the UK from the US are suggested here:

l Planned future cuts to contributory state pensions should be avoided.

l Review of the accrual rules for state pensions may be necessary.

l Auto-enrolment and automatic increases in contributions really canwork.

l High leakage rates suggest caution on giving easier access to pension pots.

New Zealand is the prime example for the citizen’s pension but it needs to be understood that the level of New Zealand citizen’s pension would, in isolation, be very inadequate. It needs extra private provision on top but there is no fiscal encouragement for this and even the citizen’s pension will need redesign by 2025, when the current arrangements will move into deficit.

The lessons from New Zealand are:

l Pensions can be made easier to understand.

l In a developed democracy, pensions need to be at least 40 per cent of average earnings.

l Private pensions can wither very fast if tax incentives are removed.

l Governments can play a key role in pension education.

Australia is often held up as the prime example of compulsory pensions. Only when this system is fully mature will it give Australians something approaching an adequate pension.

The lessons from Australia are:

l It is very important that means tested pensions do not undermine incentives for voluntary saving.

l Radical reforms are poss- ible but may lead to radical restructuring of pensions and savings.

l For low-earners, compulsion may simply divert scarce resources from critical immediate needs.

Sweden recently introduced a small pre-funded publicly managed but privately invested defined-contribution element to sit on top of its notional DC unfounded state pension.

There are near-compulsory occupational and personal arrangements on top. In total this is adequate but will automatically fall as people live longer unless they are willing to accept retiring later.

The lessons for the UK from Sweden may be summarised as:

l Means’ tests do not have to disincentivise private pension saving.

l The state pension switching from defined benefit to defined contribution makes it harder for private DB.

l Designing a compulsory savings regime is complex.

l State pension forecasting can have a positive impact on voluntary savings.

Taking all its analysis together, the Association of British Insurers’ report identifies some lessons. Beware the pension panacea – there is no one size fits all countries answer. Human psychology can be harnessed to make voluntarism work. Compulsion is not as simple or as efficient as it might seem.

Finally, means- testing usually undermines incentives to save but it can be designed to encourage voluntary saving.

The new UK Government is going to have to apply these lessons in developing its pension policy.

To me, it is clear that a lot more can be done with voluntarism in conjunction with a reform of state pensions.

Means-testing needs to be reformed. Contracting out needs to be revitalised. Perhaps most important of all, people need to be told repeatedly the consequences of doing nothing, and it should be made easier for them to do the right thing.

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