The pension reforms are not perfect, but they should help many people who are not currently saving enough for their retirement.
At the Financial Inclusion Centre, our work covers outright financial exclusion and financial under provision, where people are not making enough provision for their core financial needs.
The number of UK households that do not have a pension or are not saving enough into a pension to look forward to a secure financial future is one of our main concerns. So we were pleased to see, finally, the introduction of auto-enrolment in October 2012 which, along with the establishment of Nest (national employment savings trust) represents one of the most significant reforms to UK pensions in years.
Far from perfect
The reforms are far from perfect, as auto-enrolment is being phased in over five years and, disappointingly, as a sop to the personal pensions industry, the annual contribution limit is low at £4,400 and transfers into Nest are not allowed.
However, we do support the reforms. Compared with the current pension system, the combination of auto-enrolment and Nest should lead to better pension ‘outcomes’, contribute to financial and social inclusion, and help create better financial futures for many lower-income or ‘working poor’ households.
To understand why we take this view, it is important to understand the root causes of serious pension under provision in the UK. In addition to the failure of the three main partners (the state, employers and individuals) to fund sufficient pension provision, there is a range of demand-side and supply-side factors that exacerbate the problem. On the demand side, households face prolonged squeezes on their incomes, reducing funds available for pension contributions.
Also, the reputation of the financial sector has been undermined by mis-selling scandals that have left a legacy of mistrust. Confidence in the financial sector has been hit further by the financial crisis adding to the familiar problem of employee inertia on pensions.
On the supply side, the private pensions industry is plagued by inefficiencies, with an oversupply of providers and products such as alternative investment funds that often destroy value, over intermediation in the form of legions of advisers and consultants selling expensive services and layers of funds, and over complexity. There has been a disquieting growth in complex, risky and costly strategies involving ‘alternative’ investment funds that often fail to deliver and require further complex strategies to fix.
Also, under the voluntary system, employees have to be persuaded into, or sold, pensions. This is costly and can introduce conflicts of interest into the sale and distribution of pensions, especially personal pensions. The unsuitability of the voluntary/private pensions approach for reaching households is thrown into starker relief by the new economic reality of squeezed incomes, low economic growth, financial repression and low investment returns. Complex and costly solutions must be replaced by simplicity and value, and a pensions approach that puts the interests of employees first.
Auto-enrolment and Nest offer the potential to overcome these barriers to inclusion. Auto-enrolment addresses the inertia problem and distribution costs. Nest can create economies of scale to deliver real value for employees and employers, while the combination of auto-enrolment and the legal structure reduces the risks and conflicts of interest inherent when the pensions industry sells pensions to employers and employees.
Long-term value and simplicity are key: every 0.5% of unnecessary pension costs means employees, or employers, have to contribute an additional 11% each month over a 25-year period to make up the value extracted by the pensions industry.
So we think Nest and auto-enrolment will lead to greater pension provision, but we do have to make sure employees can access advice if they have debt problems, as it may be better to pay down debts first. The reforms should widen financial inclusion. Once people who had not previously been exposed to pensions get used to Nest, their financial confidence and capability will improve. There is plenty to build on now.
Mick McAteer is founder and director of The Financial Inclusion Centre