Memorandum submitted by the Resolution
Foundation
1. The Resolution Foundation welcomes the
Committee's inquiry into the design of a National Pension Savings
Scheme (NPSS) and the role of financial services regulation.
SUMMARY
2. The Foundation has not commented on the
merits of the Pensions Commission's proposals. However, we believe
that the reform process offers an opportunity to address the potential
advice needs of people on medium to low incomes, particularly
in relation to the proposed NPSS. This submission therefore focuses
on the following key points:
— Pensions decisions are among the
most complex and vital financial choices people make during their
lifetime. Understanding of the pensions system remains low and
evidence suggests that many people are currently failing to plan
adequately for their retirement.
— The Foundation believes that generic,
non-regulated advice[38]
has a critical role to play in helping people make the right decisions
in planning and saving for their retirement. The auto-enrolment
model proposed for the NPSS would still leave people with important
decisions to make about saving for retirement.
— The pensions reform process provides
an opportunity to ensure that advice needs are addressed. However,
access to advice is an area the Pensions Commission neglected.
This should be addressed in the Government's forthcoming White
Paper on pensions reform.
— In many respects, people on medium
to low incomes have most to gain from the proposed reforms. Under
the current system, they are saving less and are less likely to
be a member of an available pension scheme than those on higher
incomes. However, the 12 million people in this group currently
have little or no access to financial advice.
— It is essential that this "advice
gap" is filled if pensions reform is to meet its objectives
and enable people in this income group to understand their options
under the proposed NPSS and make informed decisions across their
pensions lifecycle about, for example, their projected pensions
benefits and the affordability of their contributions, and how
best to maximise their pensions assets when they reach retirement.
— The Foundation believes that generic,
non-regulated advice on pensions should be made available as part
of a broader national financial advice resource. We are currently
researching cost effective options for providing such a service,
which could be delivered through a public-private partnership.
ABOUT THE
RESOLUTION FOUNDATION
3. The Resolution Foundation is a recently
established research and policy organisation which aims to provide
new thinking on how people can access and use the financial services
system. The Foundation is not-for-profit and impartial, committed
to producing high quality socio-economic research, and to producing
practical proposals for action which are capable of being implemented
by government and industry.
4. The Foundation is currently focusing
on the 12 million people in the UK on medium to low incomes who
are largely independent of state support but who currently receive
little or no financial advice. The income levels of this group
mean that they are considered unprofitable by the financial services
industry and they therefore do not receive advice bundled with
financial products in the same way as people on higher incomes.
As they are not reliant on state benefits, they are also unlikely
to be served by services aimed at the poorest and most vulnerable
in society.
5. The Foundation believes that the lack
of advice for this group results in poor financial decision-making,
often at significant cost to the individual and the State. We
are therefore committed to researching a new national service,
which could be delivered through a public-private partnership,
to provide generic financial advice targeted on this group.
PENSIONS AND
THE NEED
FOR ADVICE
6. It is widely accepted that people in
the UK today are faced with making increasingly complex financial
choices. At the same time, the emphasis on them to take personal
responsibility for their financial affairs is increasing. Pensions
decisions are among the most complex and vital of those choices
and reform, although much needed, has the potential to add a further
layer of complexity.
7. The evidence from the Financial Service
Authority's "baseline" survey into financial capability[39]
suggests that the vast majority of people in the UK are capable
of exercising the basic financial skills needed to make ends meet
and keep track of their money. However, the survey also shows
that significant numbers of people are unable to plan their finances
effectively or, critically, choose the right products.
8. The survey found that many people are
failing to make adequate provision for retirement. Among those
who had not yet retired, it found that 81 per cent of people did
not think that the State would provide them with an adequate income
in retirement. However, of those, 37% did not have any additional
pension provision. Overall, only 42% of people surveyed were paying
into a current personal or occupational pension.
9. In terms of choosing financial products
(not just pensions products), the survey found that nearly half
(46%) did not collect any information to help inform their decision.
The vast majority of those surveyed relied simply on promotional
literature and other product information to make their choice;
only 21% enlisted independent advice in doing so. And, in making
their decision, 45% said they considered neither the product features
nor its price. The survey concluded that "people were generally
poor at choosing products, they renewed existing products without
considering alternatives, and even when they did look to purchase
something new they did not necessarily shop around." [40]
10. The Foundation strongly supports efforts
to improve financial capability by improving financial education
and information. However, these outcomes, and the gulf shown by
the FSA's findings between people's competence in basic financial
matters and their ability to plan ahead and choose products, suggest
that improving basic financial skills by providing education and
information will not, on its own, be enough to help people make
the right decisions. This is supported by academic research on
behavioural economics which shows that people typically do not
engage with long term financial planning or the risks associated
with choosing financial products without an external stimulus.
In planning for retirement therefore, as well as in making other
important financial choices, we believe that people also need
advice, accompanied by appropriate external prompts, to help them
make these decisions.
THE FOUNDATION'S
RESEARCH
11. The Foundation has commissioned a comprehensive
programme of research to understand the composition, characteristics
and needs of the 12 million people who currently lack access to
financial advice. This shows that, although very aware of the
challenges posed by the lack of pensions provision, this group
currently save less and are much less likely to be a member of
an available pension scheme than those on higher incomes.
— This group is more concerned about
pensions provision than the general population. For example, among
middle-aged workers in the group, 60% say that they worry a lot
about their income in retirement compared to 33% of people over
40 years of age among the population as a whole.
— Overall, people in this group save
less than the average at equivalent life stages. The most significant
differential is among families and middle-aged people. For example,
middle-aged workers save around two-thirds as much as the average;
£124 a month compared to the average of £179. Savings
are also much more likely to be for short term expenditure (on
holidays or a car, for example) rather than for the long term.
— The proportion of the group who are
members of an available employer's pension scheme is consistently
lower than higher income earners. For example, young people in
the group are half as likely as those on higher incomes to be
members of an available pension scheme; 32% compared to 63%.
12. This group therefore has a great deal
to gain from pensions reform. Indeed, the Commission asserts that
"the NPSS will provide to low and middle earners the opportunity
to save at the low costs currently only available to those with
higher incomes or working for large private companies or the public
sector."
THE NPSS AND
ADVICE
13. The Pensions Commission estimated that
some 12 million people who are earning and have the resources
to save for retirement are not doing so adequately. Many of them
are in the medium to low income group the Foundation has identified.
14. The proposed NPSS aims to significantly
increase pensions coverage among people on low incomes. This is
predicated on using auto-enrolment to overcome the inertia associated
with saving, improving incentives by cutting back the scope of
means-testing projected under current state pension indexation
policies and reducing costs, including those associated with providing
regulated advice.
15. However, the model proposed for the
NPSS would still leave people with complex and important decisions
to make about their pensions. As set out above, the group of people
on whom these reforms are targeted currently have little or no
access to the financial advice they need to make the right choices
in planning and saving for their retirement. The Foundation therefore
believes that it is essential that generic, non-regulated advice
is made available to assist this group in making decisions at
key points during their pensions lifecycle:
— When they first come into contact
with the pensions system, need to understand it and are first
required to make decisions about their options.
— At key points during their pensions
lifecycle, for example if their personal circumstances change,
they reconsider their retirement aspirations or the system itself
changes.
— When they reach retirement age and
need to make decisions about realising their pension assets, alongside
other issues such as considering their long term care.
16. In addition, a number of specific triggers
for advice can be identified if the NPSS is adopted:
Suitability of the NPSS
17. Under the model proposed for the NPSS,
it would pay the vast majority of people to stay within the scheme.
However, although the emphasis is on achieving high levels of
take up through auto-enrolment, the Pensions Commission recognised
that there would still be some people at the lower end of the
income scale for whom means-testing would act as a disincentive
and who may therefore wish to opt out of the scheme. Information
and advice would be needed to assist people in making the right
decision in these circumstances. The need for this would increase
further if the Commission's recommendations on containing the
spread of means-testing are not implemented.
Adequacy of savings
18. The Pensions Commission proposed that
the NPSS should be based on an overall contribution rate of 8%
of salary. [41]The
Commission estimated that this would deliver a replacement ratio
of 45% for a median earner saving from the age of 25 until state
retirement age, 30% paid through the Basic State Pension and 15%
through the NPSS. [42]
19. This may be considered inadequate for
some people. The Commission also estimated that a more desirable
replacement ratio of, for example, 60-66% could be achieved by
doubling the total contribution level. [43]Thus,
for large numbers of people, the issue of the adequacy of their
retirement income and how much they should contribute could therefore
arise. Where this does arise, it would require people to consider
their aspirations in retirement alongside their projected pension
benefits and the affordability of their contributions.
20. Evidence of inertia under the current
system suggests that people are very unlikely to engage in this
process without a "call to action" to act as a prompt.
The DWP are developing pensions forecasts to provide this stimulus.
However, the Foundation believes that there would also be a need
to provide advice to enable people to discuss their options and
engage meaningfully in making decisions about matching their retirement
aspirations and their savings.
Advice at retirement
21. The Pensions Commission did not propose
that an annuity should be built into the NPSS, although it did
recommend that reserve powers should be taken to provide annuities
should the market not be performing efficiently. This suggests
that the intention will be to allow people to "shop around"
for their annuity. Research indicates that people are currently
likely to achieve an increase in their income of 10% or more by
shopping around for the best annuity rate available on the open
market, rather than taking the one offered by their pension provider
(although only 40% currently take up their option to move to another
provider). [44]In
addition to the annuity rate, the individual will also need to
consider the type of annuity they should purchase. This is therefore
another clear trigger point for advice.
22. Specific groups are also likely to have
particular advice needs under the proposed scheme:
The self-employed
23. The Pensions Commission suggested that
the NPSS should be made available to the self-employed but did
not set out how this might be achieved. Research shows that the
self-employed often view their business as providing security
for their retirement. However, for today's generation of self-employed
people, many of whom are engaged in activities which will not
deliver an asset on retirement, this is unlikely to be the case.
As they do not have access to the State Second Pension, the self-employed
face particular challenges and their advice and wider needs would
need to be particularly carefully considered in developing the
NPSS.
Small employers
24. Those working for small employers, especially
those operating without formal structures and procedures, are
another group who may require advice on their options. Again,
although the thrust of the Pensions Commission's proposals is
to keep opt out levels low, the employer and employee may prefer
to reach an informal agreement by, for example, mutating the employer's
contribution into a cash payment. Access to advice would be particularly
important in these circumstances.
CONCLUSION
25. Despite welcome recent efforts by the
Government to increase engagement in pensions through the Informed
Choice agenda, people's understanding of the pensions system and
their awareness of their options in planning for their retirement
remain low. There is considerable evidence to suggest that, under
the current pensions system, large numbers of people are failing
to plan adequately for their retirement.
26. The reforms proposed by the Pensions
Commission and the creation of a NPSS are aimed at significantly
improving pensions coverage. However, as set out above, the auto-enrolment
model proposed for the NPSS would still leave people with important
choices to make about their pensions. The Resolution Foundation
believes that there is therefore a critical role for generic,
non-regulated advice in helping people to make these decisions.
27. In many respects, people on medium to
low incomes have most to gain from the proposed reforms. Under
the current system, they are saving less and are much less likely
to be a member of an available pension scheme than those on higher
incomes. However, they currently have little or no prospect of
getting the financial advice they need to make the right decisions
in planning for retirement. The pensions reform process provides
an opportunity to ensure that their advice needs are addressed;
this issue should be tackled in the Government's forthcoming White
Paper.
28. The Foundation believes that advice
on pensions should be delivered to people on medium to low incomes
as part of a broader national service, providing generic financial
advice to people on low incomes. We are currently developing cost
effective options for providing such a service, which could be
delivered through a public-private partnership, and will consult
on these options shortly.
March 2006
38 Generic advice is information, advice and guidance
that does not involve recommending a course of action in relation
to a specific provider's product. It is defined by the FSA as
"Services and tools that use information about individuals'
circumstances to help them to identify and understand their financial
needs and to plan their finances. Generic advice helps consumers
to identify: (a) choice and possible priorities for action which
are appropriate to their needs; (b) how to take the next steps
in addressing their priorities; and (c) how to access other relevant
sources of information and advice." [Building financial
capability in the UK: the role of advice, FSA, July 2004]. Back
39
Financial capability in the UK: establishing a baseline;
FSA, March 2006. Back
40
Levels of financial capability in the UK: results of a baseline
survey; FSA, March 2006. Back
41
Based on a contribution from the employee of 4%, a 3% employee
contribution and a further 1% in tax relief. Back
42
The replacement ratio is the ratio of income in retirement to
that immediately before. Back
43
This would require the individual to contribute 10% of their salary. Back
44
Annuities: bonus or burden; ABI, 2005. Back
| 
