The Government’s White Paper has answered many of the questions about personal accounts although some areas will require further consultation.
The key issue of compulsion has been under consideration for many years but has now been resolved and personal accounts will be based on “soft compulsion” through the mechanism of automatic enrolment. Mandatory automatic enrolment will apply to employees aged between 22 and state pension age, with employees either being enrolled into a personal account or an employerbased scheme that meets certain quality conditions.
Employees will keep the right to opt out of personal accounts, in which case they will not have to pay the minimum contribution of 4 per cent of earnings and the employer will not have to pay their 3 per cent contribution. There is an obvious incentive for the employee to be auto-enrolled as few, if any, employers will pay higher wages to employees who opt out.
Will the introduction of personal accounts give employers the excuse to abandon existing schemes to reduce costs? This is particularly relevant if they might have to amend their schemes to meet the quality test, for example, by removing an existing waiting period. Some commentators believe this will happen.
Personal accounts will bring higher costs for employers but they may be able to alleviate future costs by planning remuneration strategies in the years leading up to 2012 and from 2012 onward, for example, by paying lower bonuses or lower than intended salary increases. The phasing in of employer and employee contributions over three years from 2012 will also ease the transition.
If employers switch to personal accounts, they will have to maintain their existing pension arrangements in some form as transfers from registered pension schemes into the new personal accounts will not be permitted although this will be reviewed in 2020.
This restriction is sensible, given the complexities of transfers. It also avoids the need for advice on whether the transfer is a suitable course of action.
Some low-earners might not gain much from personal accounts because savings into the personal account might reduce means-tested benefits at retirement. This raises the issue of suitability. Should an individual join a personal account if they are unlikely to see the benefits of their personal contributions?
If an individual gets advice, the adviser’s recommendation would have to take account of the personal circumstances. The fact that an individual who opts out would lose the mandatory contribution from the employer should deter such action but the suitability argument remains.
The low-charging structure of personal accounts will not cover the cost of individual advice to sell a personal pension to someone working for a medium-sized employer, estimated by the Pensions Commission in 2004 to be around £800. Consequently, advisers will steer well clear of personal accounts although there will be a need for advice as, typically, personal accounts, together with state pensions, will provide only 45 per cent of average earnings at retirement.
The White Paper states in the executive summary: “Some people will rightly decide not to save for a pension. They could include those on persistent very low incomes or those struggling with high unsecured debt.
Hopefully, a consensus will build up over the White Paper proposals and the sensible approach adopted so far will be maintained. However, a lot can happen between now and 2012.
Tony Reardon is principal of Reardon Consulting