Select Committee on Work and Pensions Minutes of Evidence

Examination of Witnesses(Questions 40-59)



  40. A final question, a more technical one, if I may, Mr Pickering. Would you abolish contracting out, which is terribly complicated and I confess we do not all understand—
  (Mr Pickering) Yes, I have said that by 2030 my own view is that there should be one universal State Pension out of which neither rich nor poor will contract out. The challenge, as ever, is to get from where we are to where we want to end up. Contracting out is enshrined in our system at the moment and we said in our report that there are two schools of thought. One which says abolish it because it is past its sell-by date, another which says that it is redeemable if the terms are made attractive. I think that as the Government prepares the Green Paper and decides on how best to allocate taxpayers' money to incentivise pension accumulation, the continuation of contracting out does need to be put under the spotlight. If the Government does nothing, then it is going to lose contracting out by default anyway because the bureaucracy is over-burdensome and the financial deal is too tight.

  41. So would you abolish it?
  (Mr Pickering) I would abolish it by 2030 definitely.

  42. I was thinking of a little sooner than that. Would you abolish it within the next five years?
  (Mr Pickering) I think the case for moving quickly to a universal State Pension is compelling, but I would not wish to make a statement on contracting out alone which does not have due regard to tax incentives and other incentives. But I am unequivocally happy to say that contracting out should not remain a permanent feature of the UK pension system.

James Purnell

  43. On that last point about tax incentives, can I ask you both whether you think that the current tax incentives are well aimed at encouraging saving for a pension?
  (Mr Sandler) Without being specific as to pensions for a moment, I will come onto pensions, if I may, one of the interesting pieces of work which the team who helped me on this uncovered relates to the whole question of tax incentives as a device for encouraging further savings. There is a wide body of evidence which suggests that tax incentives do not actually stimulate new savings. What they do is they redirect savings which would, in the main, otherwise have taken place towards more tax efficient vehicles. Furthermore the provision of tax incentives actually adds further cost and complexity to the system. So there is a clear negative associated with introducing tax incentives to stimulate savings and no clear evidence—in fact arguably no evidence at all—that new savings are actually stimulated, that people consume less when confronted by new tax incentives. Which led me to the message which is contained within this review, the message to Governments both now and in the future, that the driving objective of tax policy in this area, the savings area, should be on simplification and cutting through this Gordian knot of tax complexity that has been built up, rather than adding further complexity to the system by putting new tax incentives on the statute books. As far as pensions specifically is concerned, pensions is one form of saving. It is a very particular form of saving. There is no question that tax incentives, correctly applied, do drive savings away from non-pensions vehicles towards pensions vehicles. Whether that is enough or to the correct level, I am in no position to say. Roughly 50 per cent of private savings in this country are in pensions vehicles. I do not think it is for me, or indeed anyone else, to say that 50 per cent is the right number as opposed to 70 per cent or 20 per cent. We can all talk about savings inadequacy, but should that savings be in the form of pensions as opposed to in the form of some other financial vehicle, I am not sure that there is any objective answer to that question.
  (Mr Pickering) We see figures that suggest that tax incentives to pension schemes cost the Exchequer or the taxpayer £14 billion a year and it is quite natural that those such as you, charged with the responsibility of guarding the public purse, want to know whether the public is getting value for money for that £14 billion. However, you have to remember that it is more tax deferral than a tax incentive. You ultimately pay tax on your pension if you draw enough to lift you above the personal retired persons allowance. It is more tax deferral than a tax incentive. But I think that tax deferral is a very important incentive to persuade people to save long term. The fact that you do not pay tax on the money until you actually have the money at your disposal to spend is perhaps the only reason why people would save through a long term pension savings vehicle rather than through a bank account or an ISA because the net effect of the ISA tax regime is not much more attractive to a basic rate taxpayer than the tax regime applicable to a pension scheme. So tax incentives, although helpful, perhaps are not helpful enough and therefore, as the Government searches for ways, in Andrew Smith's words, of aligning incentives for employers and employees to save through a pension, one may have to look slightly wider than pure tax incentives. There are examples from overseas where employers are given some incentive to remunerate the workforce partly in pension form. We have already heard discussion about Government-financed baby bonds to get babies in the savings habit. One could use similar public subsidies to give a Stakeholder Pension a kick start. So I would suggest that you, as politicians, should not just look at tax incentives, contracting out rebates or other forms of incentive in watertight compartments. One has to take a holistic view as to how much of the taxpayer's hard earned money does one want to use to incentivise saving through a pension. And there are a number of ways of putting those incentives in the system; tax deferral is but one of them.

  44. Some people say that that regime is more attractive for higher earners than middle earners and we seem to have identified, over the course of this morning, that there is more of a problem with encouraging middle and low earners to save. In that respect, do you think that having a higher rate relief, which means that higher earners are benefiting at 40 per cent and low earners are benefiting at 22 per cent from the current rate, do you think that is a justified system or do you agree with the findings of the YouGov poll, that actually people think that that should be the other way round, there should be more of an incentive for lower and middle income people to save rather than people on higher incomes?
  (Mr Pickering) What you must not do is compartmentalise people into basic rate taxpayers or higher rate taxpayers. There are some manual workers who have good years and bad years. There are some white collar workers who have good years and bad years. We really want to encourage them to save as much as they can when they are going through their good years. So I would not withdraw 40 per cent tax deferral. One could think about providing basic rate taxpayers with notional 40 per cent tax relief on their contributions. What one must not do is leave the employer out of this equation because all the evidence suggests that those who are better off in retirement are those who have had an employer who has played an active part in pension accumulation. We can make life easier for employers by removing some of the current needless bureaucracy. You may well want to think about providing other more tangible incentives for UK employers, like their US counterparts, to remunerate the workforce in part pension form rather than in purely cash form.

  45. So they would get more of a tax break on pensions contributions than on salaries?
  (Mr Pickering) Yes, that is one way of doing it. And indeed, one of the ways the Americans look at it is through take up. If you have take up across the income spectrum within your company, you are put at fiscal advantage vis-a"-vis those of your competitors who only have take up at the top end of the income scale.

  46. Mr Sandler, do you have any views on the top rate of tax—
  (Mr Sandler) No, I do not think I do. I think we are getting here into the realms of pensions policy specifically and that is not an area that I spent any time looking at.

  47. Can I ask one final question? Some people say that people do not understand tax incentives and only very specialised or in fact only professionals understand it and it would be better to have a kind of matching scheme where people could see their contributions being matched by some money from the Government and/or their employer. Do you both have views on that?
  (Mr Pickering) It is all part of the bigger picture that I mentioned before. It does not really matter what you call it. If my savings are boosted by a payment from someone else, then it makes that savings process more attractive. At the moment, if you take out a Stakeholder Pension, if you put in, say, £2,808 then the rest of us as taxpayers gross that up to £3,600, so it is a very visible enhancement; 2,808 in becomes 3,600 immediately when you get the tax back. Now I do not care whether you call that tax back or "Bog off"—buy one get one free, it is actually providing a supplement to the net contribution that the consumer themselves makes.
  (Mr Sandler) I do devote a section of the report specifically to that issue and come to the conclusion that there is evidence out there that matching schemes are more beneficial in terms of creating some incentive for people to save. That, by and large, when confronted by the prospect of an enhanced tax relief or some form of tax relief, most consumers do not know how to evaluate that and are not particularly motivated by that particular thought, but the concept of having a contribution towards some savings vehicle matched in monetary terms, to some degree by some third party, is something which people tend to have a positive reaction to and therefore, again, there is a message here which says that those sorts of schemes are more likely to have applicability.

Andrew Mitchell

  48. Can I just check on something and, in doing so, I should draw the Committee's attention to my entry in the Register of Member's Interests. Mr Pickering, I was not sure I understood this; I thought you said, at one point, that for someone saving money there was not a huge difference between an ISA as a vehicle and a pension and that the tax relief for a basic rate taxpayer would not make that much difference. Is that what you actually said? Because it does seem to me that a 22 per cent lift on what you put into your pension is actually quite a big difference from the ISA regime.
  (Mr Pickering) Yes. What we have not got at the moment is a proper savings hierarchy. Although the contributions that you pay into your ISA are after tax income, you can take the proceeds out entirely tax free. In a pension scheme your contributions are tax deductible, but the output is, by and large, taxed. So the net effect is the same. In an ISA your contributions—in technical terms it is TEE—are tax exempt exempt. Whereas in the pension scheme it is largely exempt taxed. The net effect for a 22 per cent taxpayer who has not got a capital gains tax problem is that an ISA, in purely tax terms, ignoring employer contributions to pension schemes, is very attractive because of its innate flexibility, flexibility which is not present in a pension scheme.

  49. I think I did understand you correctly then. I would just like to say that I think for many people who are on defined contribution pension schemes, given that 22 per cent uplift and given the effect on the outcome of the performance of the markets and so on, there is quite a big difference, I would submit, between someone embarking upon an ISA and embarking upon a defined contribution pension arrangement.
  (Mr Pickering) Only if there is an employer contribution.

  50. Yes, but nevertheless someone who is embarking on one or t'other of those two arrangements, there is a significant difference to them in terms of the value.
  (Mr Pickering) I would differ with you on that. From a 22 per cent taxpayer's point of view, the only thing that gives the pension the head start is the fact that you can take some of the proceeds tax free at retirement. That is the only thing that gives a pension scheme a head start over an ISA, unless there is an employer contribution and when we are talking about basic rate taxpayers—

  51. We will have to agree to differ.
  (Mr Pickering) We will do the sums afterwards.

David Stewart

  52. I would like to raise some questions about occupational pensions. Most of my questions are aimed at Mr Pickering, but Mr Sandler please feel free to come in at any time. Mr Pickering, in your report you say that nearly 50 per cent of employees have occupational pension arrangements and as we all know, there has been a shift from the final salary type model to the defined contribution model. We can all perhaps give ten or 11 reasons why that is, but three, without any particular order, would be issues such as the volatility of the stock market, the minimum funding requirements and, of course, the FRS 17 Accounting Standard. What can the Government do, if anything, to encourage employers to retain the final salary schemes?
  (Mr Pickering) I do not think that the Government should do anything to encourage particular sorts of pension provision. Government should create a level playing field where employers and employees can jointly decide whether they want a defined benefit scheme or a defined contribution scheme. The Government's real concern is not with scheme design, but with the size of the contribution. Whether it is defined benefit or money purchase obviously has an impact on who bears the investment risk, but other things being equal, the same level of contribution paid into either sort of scheme should produce the same output if an identical investment strategy is pursued. There are lots of other things being equal there that are not always equal, but the Government's concern should be to make sure that employers pay hefty contributions. It is then for employers and employees to determine whether that is in the defined benefit vehicle, a money purchase vehicle or a mixture of the two. The employer underwrites a chunk of the risk up to a certain level and then the members shoulder the risk beyond that level.

  53. Notwithstanding these comments, would any of your recommendations, if enacted in law, stem this tide of change between the final salary and the shift towards defined contributions?
  (Mr Pickering) It might have a marginal effect this time round, but what it will do is allow the pendulum to swing back much more easily than would be the case if there was still this very steep difference between an employer-sponsored defined-benefit scheme, where the Government gets involved in minute detail with scheme design, when compared with a money purchase scheme, where the Government does not affect the employer at all in terms of scheme design. The pendulum has, in the past, swung periodically from defined benefit to money purchase and I am sure it will swing back from money purchase to defined benefit again in the future. Not necessarily a final pay gain, but a revalued clear average scheme which is a much fairer form of defined benefit scheme. So in the short term, we might make a marginal difference. In the long term, I think we will make a substantial difference if the Government accepts our recommendations in allowing scheme design to be undertaken at the workplace rather than in Parliament.

  54. So if I have understood you correctly (and stop me if I have not), would you say that it is not really a question of saying, in some naive way, that final salary: good, defined contribution: bad? What is crucial then is that employers and employees contribute as much as is possible over the employee's working life.
  (Mr Pickering) Yes.

  55. Right. Thank you. This is for both of you; how do you react then to proposals, in both of your reports, to restore confidence to many employees who, of course, have lost confidence with the current problems that have been highlighted, particularly in the tabloid press?
  (Mr Pickering) Some of the problems are based on unrealistic expectations. Not all, but some people are expecting the pension system to deliver more than it was ever promising. People get this two-thirds figure in their mind and yet very few people are on course for a two thirds pension. The Pensions Act has been around since 1995 and has not really stopped the flow from defined benefit to money purchase and the accompanying reduction in employer contribution. So the Pensions Act is not providing the sort of consumer protection that you are looking for. I think what will give consumers a boost in their confidence is if the three main political parties put their shoulder behind a new kind of Pensions Act, a new kind of regulator which is much more risk based rather than bureaucratic box-ticking based, so that it would really root out fraud rather than spend hours chasing a scheme where the pay clerk happened to be off sick and contributions were paid in late. That is what we are doing at the moment. It is an absolute nonsense. But I think we have all then got to say to the consumer that absolute security is absolutely unaffordable. If we try and build in so many insurance premiums to protect against every adverse eventuality, we will price the activity out of existence. I know that is not a very palatable message to give, but there are other walks of life where people happily accept that absolute security is absolutely unaffordable. Your colleague spoke earlier on about buying a two seater sports car. Now, there is no absolute security of safety when driving a two seater sports car, but people still do it. And yet, when it comes to financial services, they chase this holy grail of guarantees as if guarantees cost nothing. Guarantees cost something.
  (Mr Sandler) I think the question about confidence was really posed in the context of occupational schemes and that is an area where I have no particular views to offer. If, however, the question is posed more in terms of the area that I am a bit more qualified to express views on, confidence in the retail savings industry in general, it remains my belief that the fundamental absence of confidence that does exist, and there is plenty of evidence that this is the case, arises from consumers' inability to understand the industry. It just comes across as too opaque, too difficult, to complicated, too hard to engage with, requiring too much professional support, requiring expertise that they do not have and if you add to that the odd financial scandal that has emerged in the course of the last 10 or 15 years, pensions mis-selling, Equitable, endowment mortgages, split cap trusts, the combination of all of that simply serves to erode confidence still further. If you believe my view that it is in the inability of a consumer to understand what is going on that is the principle cause of the absence of trust and confidence, that can only be overcome by creating an industry which is easier to understand, which offers more simple products and more transparent ways where the consumer can look at one product, compare it with another and make a respectable choice and where he feels his adviser is actually acting for him as opposed to really being a commission-based salesman for the product provider, which is, in the main, the reality today. So again, a lot of the recommendations here drive towards that sort of world. I do believe that it is possible to bring a very considerable degree of consumer confidence of this industry over the passage of time.

Ms Buck

  56. Thank you. Mr Pickering, you were asked earlier by Anne Begg about the issue of compulsion which was a line of questioning I was going to develop. I think you very satisfactorily answered the question and gave us a very clear analysis of why you feel that there are limits to the issue of compulsion.
  (Mr Pickering) For the avoidance of doubt on that, in my report I did say that where employers wanted to make pension scheme membership a condition of employment, they should be allowed so to do. Again, this was an option open until 1988 when the Government then said that you could not make membership of a pension scheme a condition of employment. I do not know that there are thousands of employers queuing up out there wanting to make pension scheme membership a condition of employment, but if there are ten employers who want to and the law frustrates them, then that law is an ass.

  57. You brilliantly preempted exactly what my question was going to be, which was to say; in the light of the critique that you made of compulsion, it did not seem to me to be terribly consistent with putting forward that proposal. I think what you are saying to us is that there is a case for flexibility regardless, but I do not see how your criticism of the weaknesses of any form of compulsion within the system could possibly be consistent with this. Would not the very difficulties that you explained to us earlier apply in these circumstances? And therefore why on earth should you want to introduce it even for a small number? And subsidiary to that, why on earth would any employer schemes want to go down that path in your view?
  (Mr Pickering) On the first issue, what I have said in my report is that an employer who wants to make pension scheme membership a condition of employment should pay a contribution so that it is not just the employee who is being compelled to contribute their own money, there is an employer contribution of at least, say, 4 per cent to give the process a kick start. You then asked me why should any employer want to do it. Before 1988 most employers who ran pension schemes did do it. They said to people "If you want to come and work for me, then you have to join my pension scheme" and they had all sorts of motives. Some paternalistic, some hard nosed commercial ones that having got a good quality person, you wanted to try and hang onto that good quality person and one way of doing that was to give them pension rights they might find it hard to replicate somewhere else. Now, today we are probably less paternalistic as a society, but there are some employers out there who do want to make sure that none of their employees fall through the net and all take full advantage of whatever pension provision is on offer at the workplace and I would not want to frustrate those employers in that desire.

  58. Clearly, at the moment and in certain parts of the country we are in a very tight labour situation and yet the trend in some other aspects has been against the better level of pension provision, the final salary provision. So is there not an inconsistency in that?
  (Mr Pickering) I am not saying that in order for a scheme to be made a condition of employment it has to be a final pay plan. All I am saying is that there should be an employer contribution of at least 4 per cent and I think that there is already a perceptible change in the recruitment market in that people are now saying to potential recruits "If you come and work for me, there is a good pension scheme". In the past, employers never got all the bang for the buck that they deserved in running such a scheme. One of the positives flowing from increased media attention in this field is that people will increasingly value a pension that comes with the job rather than a job that comes without a pension.

  59. Thank you. Can I just ask you one other question? The overwhelming evidence to the inquiry has not supported compulsion and I think that most of the evidence would generally support the kind of approach that you are talking about, but clearly there is some opinion out there which believes that this is the only way necessary. Were the Government to go down that path, it is highly unlikely but were it to go down that path, can you see possible weaknesses in the kind of wider context in terms of, say, compulsory pension contributions driving out or even driving down savings elsewhere?
  (Mr Pickering) There are obviously black economy type effects which you do not need me to articulate here. There is the other danger to which you hint at the end, that if you have a compulsory minimum contribution, that then becomes the normal contribution. That can be overcome. The Australians began with a very low compulsory contribution rate and then over the years they have ratcheted that up to somewhere around 9 per cent, but I do not think in Australia that there is a lot of evidence that the majority of employers paid above the compulsory rate. So at least in the interim you run the risk of people dumbing down to the compulsory rather than remaining at their present level. But that is a marginal issue when compared with the other disadvantages of compulsion to which I referred earlier on.
  (Mr Sandler) Again, the question is posed very much around employer compulsion and occupational schemes, so I sort of move out of that world and move into the world of compelling individual consumers to set money aside. I think that is a hugely complicated area. There are arguments for and against and I am certainly not in control of all of the merits of those respective arguments. I looked at the subject very briefly in the course of my work and all I would say, at this stage, is I know enough to know that you do not leap feet first into that world. There are all sorts of unanticipated consequences when you actually compel individual consumers to consume less and save more. But I would also say that there is a great deal that can be done to improve the way that this industry functions and it seems to me that it is not wholly advisable to leap straight into compulsion before all of the other avenues have been fully explored. That is not to say that they cannot be explored simultaneously, but my advice to the Government, to the FSA, to the industry is work hard to try and stimulate consumer demand through the more obvious levels rather than compel consumers to buy products where currently they are reluctant.

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