As pensions reform looms for the UK in 2012, there are lessons to be learned from countries that have already introduced new models for pension funding, says Tom Washington
With statutory pensions reform due to come into effect in the UK in 2012, introducing auto-enrolment, compulsory employer and employee contributions and personal accounts, the government aims to increase retirement savings and reduce the population’s reliance on the state. Several other nations across the globe, faced with similar problems, have already implemented new pension models, with varying degrees of success. Their experience provides some insight into how the new pensions regime will fare in the UK.
New Zealand, for example, introduced its Kiwisaver scheme in July 2007 in an attempt to kick-start the saving habits of a nation where only 14% of staff were taking part in employer-sponsored pension schemes. Kiwisaver is a retirement savings initiative that allows members to build up their savings through regular contributions of either 4% or 8% of their pay. Employers also make compulsory contributions, which are being increased at the rate of 1% a year until they reach 4% in 2011.
This was the world’s first voluntary state retirement savings scheme to use auto-enrolment, and anyone aged between 18 and 65 years is automatically signed up when they start a new job. There is an opt-out period of four weeks, but a government-funded NZ$1,000 (£367) tax-free payment operates as an incentive for staff to join the scheme.
By September 2008, more than 800,000 people had signed up – almost half the working population. Andrew Dickson, senior business development manager at Standard Life, says: “Its principal objective was to populate a defined contribution (DC) savings environment. Unlike the UK, New Zealand had no real savings culture, so had to make it attractive by practically bribing people.”
The strength of auto-enrolment systems will be tested in the UK, as employees will also be able to opt out. Dickson says: “Will lots of people in the UK opt out in 2012? Maybe, but there is strong evidence from New Zealand that they won’t.”
The Kiwisaver scheme also includes a provision for people to withdraw up to NZ$5,000 (£1,835) from their accounts in certain circumstances, for example when buying their first property, in times of severe hardship, or if they become severely disabled before retirement. Some US schemes, under the country’s 401(k) retirement savings model, also include an early payment provision.
Set up in 1986, 401(k) is a private pension offered through employers as an add-on to the US social security scheme, but with no compulsion for employers to provide a scheme or contribute to it. Unlike personal accounts, it is not an individual pension plan, but rather a vehicle for staff to make additional savings to top up any social security provision. There is also no requirement for annuitisation at the end of the 401(k) process, with most savings taken in cash lump sums either at retirement or before.
Unlike the Kiwisaver and 401(k) plans, Australia’s Mandatory Superannuation Guarantee Fund places the responsibility for retirement savings on employers. This was introduced in 1992, when every employer was made to contribute a minimum of 3% of salary to their employees’ pension funds. Now, all employees aged between 18 and 70 years who earn more than A$5,400 (£2,400) a year receive a minimum contribution of 9% of their annual salary. As with UK-based DC schemes, members have a choice of investment options, and the benefit is locked in until “preservation age”, which is set at a minimum of 55 years.
However, Bob Sperl, senior international consultant at Watson Wyatt, thinks that the UK experience will differ as employees have the right to opt out. “The real threat to the UK is that the introduction of the semi-mandatory arrangement might make employers think they need do nothing more,” he says. “If you compare it to Australia, you see that what makes these plans effective is the need for everyone to have one.”
Dickson believes that auto-enrolment in the UK, even with the facility for staff to opt out, should help build engagement with pensions, leaving employers to spend their communication efforts on investment levels and risk. “Traditionally, the vast majority of employers’ and providers’ resources is spent on communication and education. Auto-enrolment means you can use this resource for genuine engagement, so people are investing more and in the right places.”
Sweden’s pensions model has succeeded in engaging the population since it was introduced in 1994. Under the new system, each employee’s pension is based on the amount accumulated in two separate accounts: a notional account maintained by the government on behalf of the member and a privately-managed account. The overall contribution rate of 18.5%, of which employers and employees both pay 9.25% is split between the schemes, with 2.5% going into the individual accounts. A key feature of Sweden’s success was selling the concept of individual accounts to people and engaging them with their own retirement savings. Swedes receive annual statements in orange envelopes, outlining what they have invested and what they stand to get on retirement.
Both Sweden and Australia have succeeded in reducing employees’ reliance on the country’s social security system when they retire. This achievement is something that Chile aimed to do when it reformed its pension system in 1981, however some observers say cracks are beginning to show in the simple scheme. Currently, Chile’s employees must contribute 10% of their annual salary, while employers are not obliged to contribute anything. The pension funds are run by independent, commercial, regulated authorised providers, so employees are left to pick up the administration charges, an issue for the low paid. With no auto-enrolment or cash incentives to join, take-up has been much lower than hoped as workers try to avoid it.
Neil Latham, principal, corporate DC consulting at Punter Southall, says the UK can learn a lot from the Chilean model, but must be wary of repeating its pitfalls. “It looked great at the start and appears to be working to an extent,” he says. “It tried to get everyone saving by giving individual responsibility, but no auto-enrolment and high administration charges mean many simply want to avoid paying contributions.”
“We have not got a good track record on delivering big projects,” says Latham. “We have existing structures, so why aren’t we using them? HM Revenue and Customs is capable of collecting millions of pounds from thousands of employers on a weekly basis, but it is not going to be used.”
With millions reliant on the UK’s welfare state, the stakes are set high for the 2012 pensions reform. Whether the government has learned all it can from similar schemes around the world remains to be seen.
Global pension schemes:
Auto-enrolment with a short opt-out period has seen almost half the working population join the Kiwisaver scheme. Early access provision for first-time property purchase, severe hardship or disability, and a NZ$1,000 “kick-start” contribution have been strong incentives for people to join.
The Mandatory Superannuation Guarantee Fund is a full compulsion scheme with every employer having to contribute 9% of employees’ salaries. This has ensured a high level of preserved retirement provision for all workers.
There is no compulsion for employers to provide or contribute to the 401(k) plan, but many provide it as a vehicle for employees to make extra savings to top up any social security provision. In schemes where early access is available, participation is 3% higher and employee contributions are on average 1% of salary more.
The Swedish scheme has mandatory contributions of 18.5% of annual salary, reducing reliance on the country’s social security system. Members receive annual statements, informing them of their savings and how they will translate in retirement.
This is a simple model based on mandatory individual accounts and private administration. But no compulsion for employer involvement and high administration charges have resulted in workers trying to avoid it.
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