Fool's Eye View

[ June 14, 2000 ]

Pension Palaver

By Christopher Spink (TMFEagle)

Great Titchfield Street, London -- One of the Government's biggest worries is how to fund old age pensions. With people living longer, the drain on public resources from pension demands has risen inexorably over the past twenty years to worrying and burdensome levels. Reform of the antiquated system of pension provision is vital for the future welfare of the country. More people will have to save for retirement privately on their own, because the Government won't have enough money to provide exclusively for everybody.

Yesterday Rob Davies (TMF Essex) and I met Frank Field MP. Soon after he was elected Prime Minister, Tony Blair asked Field to look into welfare reform and in particular an overhaul of Pensions legislation. This he duly did as a Minister at the Department of Social Security, only to see his plans rejected, leading to his resignation from the Government.

Field's basic idea to tackle the problem is to introduce a "universal" stakeholder pension. This would guarantee a minimum income for pensioners of more than £120 a week. That is roughly double the present basic state pension of £66.50 a week, and way above the minimum income guarantee of £78.50, which a pensioner can expect from the welfare system.

The idea is that this will encourage people to save and consequently at the same time keep as many people as possible off benefit in retirement. This "modest" guarantee would make a massive difference to those living around the poverty line. This all sounds very well in theory but how exactly in practice should such a massive overhaul be implemented?

Field was pretty dismissive of the present CAT-standard stakeholder plans the Government has proposed. He reckons they appeal to those earning at or around the average income of £25,000 a year but do little to solve the real problem of encouraging those earning less to save. Also he feels such stakeholders hardly reform the pensions system at all.

Originally Field hoped to make the system more simple, by reforming it root and branch. He says that any future pensions reform should begin "by taking some existing pensions legislation off the statute book". All stakeholders, as they are currently planned, seem to offer is another Personal Pension Plan with restricted charges, which nevertheless could still be hijacked by Wise financial services companies.

Fools on the Pensions discussion board often seem so confused by the complications of pensions that instead they seem to be opting to save for retirement via the Treasury's tax-incentive: the Individual Savings Account (ISA). A couple of weeks ago I summarised the Pensions vs ISAs debate.

Since then speculation has mounted that the Treasury might take a further step and follow the US system of retirement savings by introducing some kind of lifetime ISA. This would be like the US Individual Retirement Account or company 401(k) plans. For more information on these look at the US Fool's Guide to Retirement. They are essentially ISAs designed to help individuals save for retirement in a flexible way.

These US schemes positively encourage saving for retirement. Most UK equivalents have one huge and inflexible drawback in the form of the annuity. By the age of 75, three-quarters of the savings in an individual's pensions pot must be used to buy an annuity from an insurance company. In return this will give a guaranteed annual income for life.

Nowadays annuity rates are much lower than they were during periods of higher inflation. So this annuity condition is now a serious drawback and disincentive for people to use pensions to save for retirement. Field agrees with this. He is a member of a House of Commons Working Party that is discussing reforms to the annuity condition.

He suggests that the Government should only make pension savers purchase an annuity that would be enough to pay out the annual minimum income guarantee of £4,079. That would ensure that those people wouldn't have to rely on the heavily stretched benefits system to fund their retirement. This is the main aim of the Government. Anything else in the pension pot could be used as the individual sees fit.

If this annuities proposal went through, then pensions would immediately become a much more attractive retirement savings vehicle. The trouble comes in deciding how much is required to fund such an annuity. This would effectively become the compulsory or universal stakeholder pension plan. Then ISAs could fund the rest of retirement savings on top of that.

However, with Frank Field out of office and Tony Blair too scared to implement what would in effect be seen as a massive poll tax in what could be an election year, the possibility of such whole scale sweeping reform looks unlikely. That is a pity for Fools and Wise alike.

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Related links

Fool's Eye Views:
• Pension Knowledge Gap
• Pensions vs ISAs
• Pensions discussion board