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Select Committee on Economic Affairs Fourth Report



9.1. This chapter examines the variety and extent of private opportunities to accumulate financial resources for retirement. The Government have emphasised the importance of creating a simple and secure environment in which individuals can exercise choice about how much to save for their retirement. We review evidence submitted to the Committee which raises questions about the extent to which the Government's aspirations for an increase in voluntary pension saving are likely to be achieved.

Opportunities for private provision for retirement

9.2. Saving for retirement is currently a matter of individual choice, beyond the compulsory contributions to the National Insurance scheme, and to the State Second Pension or an appropriate contracted-out pension scheme. Payment into an occupational, personal or stakeholder pension is the most common means of making additional financial provision for retirement. However, people may save for retirement in many different ways, including buying their home or investing in their business.[93]

9.3. Use of home equity to finance retirement is still unusual in the United Kingdom, despite the substantial resources tied up in owner-occupied housing (over 59 per cent of persons aged 35-59 own a house worth more than £100,000).[94] One reason for the low take-up of equity release is a lack of consumer confidence in the products being sold (Q734-5). The FSA told us that equity release provided through a lifetime mortgage will come under FSA regulation from 2004, but that equity release through home reversion plans will remain outside the FSA's regulatory remit.

9.4. In order to strengthen consumer confidence in equity release products, we recommend that all such products be brought within the FSA's regulatory jurisdiction as soon as is practicable.

9.5. Pension plans are the most popular means of saving for retirement, but this type of saving may not be appropriate for all people, either because of their life-cycle stage or their low level of income. Although there are clear financial benefits in commencing pension saving at a young age, many people in their 20s and 30s face significant levels of debt repayment (because of previous periods of study, or property purchase) and experience increased expenditure with new family responsibilities; thus their financial capacity for retirement saving may be severely circumscribed.[95] The saving capacity of people on relatively low incomes is also likely to be limited.[96] Furthermore, evidence from the Actuarial Profession suggests that, on the basis of the current UK pension regime, for persons earning below about £20,000 per annum the rate of return on any additional pension savings they make may be very low (Q965).

9.6. The majority of people not currently saving explain their behaviour in terms of a lack of spare money. Some of these face binding financial constraints; others value current consumption more highly than the future consumption which their savings will permit. The prospect of more means-testing in old age, and the recent experience of poor returns on equities, serves to shift preferences towards current consumption and away from saving.[97] A survey conducted in 2002 by the Consumers' Association revealed that 65 per cent of respondents thought they were not saving enough for a comfortable and secure future, or were unsure as to whether their savings were adequate, but the great majority of that 65 per cent said that they could not afford to save more.[98]

9.7. A rising level of consumer indebtedness is a further barrier to pension saving (Q454). Average personal debt has grown at almost double the rate of average earnings over the past decade, and, according to the Financial Services Authority, 6.1 million families have some difficulty meeting debt repayment.[99]

9.8. The Government encourage pension saving by the provision of tax incentives. According to estimates produced by the Pensions Policy Institute, tax relief on private pension contributions currently amounts to about 1.5 per cent of GDP, and much of this tax relief benefits higher-rate taxpayers (Q918). However, the overall tax treatment of pensions is broadly neutral over time, since the tax relief on pension contributions is balanced by the tax levied on pensions paid out.[100] We note, however, that the tax-free lump sum represents an exception to this general principle of tax neutrality (QQ845, 848). Since there is no requirement for the tax-free lump-sum to be used to provide an income stream in retirement, this particular tax advantage does not appear to be an efficient way of encouraging individuals to make private financial provision for their retirement.

9.9. We therefore recommend that the Government should consider phasing out over time the tax-free lump sum.

9.10. The Government are committed to sustaining and expanding the voluntary basis of pensions savings and to maximising choice within this voluntary savings regime (Q1114). In 1998, the Government expressed their desire to expand voluntary pension provision, in order to shift the source of retirement income over the next fifty years from a public/private ratio of 60:40 to one of 40:60; this implies a more than doubling of the relative contribution of private resources to total retirement income. The Secretary of State for Work and Pensions suggested that this ratio should be seen more as an indicator of the desired direction of change, rather than as a specific target, since it is not wholly within the Government's power to determine this ratio; much depends on private economic behaviour (Q1123).

9.11. Notwithstanding the Secretary of State's downgrading of this ratio from a target to an "aspiration" (Q1123), it is clear that for the Government's goals to be met, private provision for retirement will need to increase substantially above current levels. We received evidence from Mr John Hawksworth (Head of Macroeconomics, PricewaterhouseCoopers) which suggested that, although the level of private pension income as a share of GDP is likely to rise over the next four decades, it will do so more slowly than the rate at which the population aged 65+ is expected to increase (Q243). Projections of this sort are always subject to a wide margin of error, but we are concerned that the Government's objective of a substantially higher level of private pension saving may not be attained. A shortfall in anticipated financial resources in retirement could have a negative impact on the welfare of future retirees, and also on public finances if some future Government were called upon to fill the savings gap.

9.12. We have therefore given some consideration to the conditions under which we believe a voluntary savings regime is likely to be successful. We believe that for voluntarism to succeed, it is necessary that individuals have:

  • adequate information to make informed choices
  • adequate access to appropriate savings instruments
  • an ability to make coherent and consistent long-term financial plans
  • an ability to adhere to such plans once made

9.13. We are unconvinced that these conditions apply to a sufficient degree to support the desired expansion of private pension savings within the United Kingdom. We note with approval the plans the Government set out in last December's pensions Green Paper to increase understanding and knowledge of pension savings.[101] We also recognise that the Government are far from complacent with respect to these issues: the Secretary of State for Work and Pensions agreed that the Government have "a long way to go" in their information campaign with respect to pensions (Q1111). We nevertheless believe that the Government can and should do more to create a more supportive environment for voluntary pension savings.

9.14. A fundamental requirement for coherent pension planning is that individuals should have full information about the way in which private pension systems work, about how they are financed, and about the cost of alternative pension outcomes. We received consistent evidence from employer organisations and actuaries that members of occupational pension schemes have "no concept of how valuable their pension is" (Q948), give little consideration to the value of pension benefits when they are involved in job search (Q592), and only begin to consider the details of their membership once they reach their mid-40s (Q632). This implies that a large segment of the labour market is characterised by potential inefficiency: workers who do not take account of the non-wage element of their remuneration package may select sub-optimal employment; and employers who make substantial contributions to their workers' pension schemes may not benefit from this non-wage expenditure in terms of enhanced recruitment and retention of employees.

9.15. The Government have advocated the issuance of an annual "total benefit statement" by employers to help employees recognise the value of employer pension contributions.[102] While this is a laudable aim, it may also have considerable cost implications for employers. A simpler option would be to include employer pension contributions on pay slips, and to explicitly state the value of employer pension contributions in all salary calculations, whether on pay slips or in job advertisements. We believe that this would facilitate rational decision making on the part of workers engaged in job search, enhance awareness of the value of employer pension contributions, and encourage take-up of pension scheme membership.

9.16. We therefore recommend that the Government set an example by explicitly including information on the value of employer pension contributions in pay slips and in recruitment material for all public- sector jobs. We further recommend that a timetable be established for extending this practice to private-sector employment.

9.17. A further barrier to private pension saving is a perceived difficulty in obtaining unbiased financial advice.[103] Many consumers believe commission-based advice is biased, but there is a reluctance to pay up-front fees. The Government have made it clear that they would like employers to take a role in providing information on pension planning to their staff.[104] However, a number of witnesses noted that FSA rules relating to financial advice serve to prevent employers from taking on this role (QQ464, 674, 742).

9.18. The FSA acknowledged that its rules governing the provision of financial advice are a major barrier to the effective provision of detailed pensions advice by employers, and pointed out that it is working with DWP to develop an employer information pack (QQ868-875). We were persuaded by the argument that many workers would rather receive advice about pension planning from their employer, with whom they are likely to have a long-term economic relationship, than from an itinerant financial adviser.

9.19. We conclude that the Government's policy goal of encouraging the delivery of more financial advice to individuals via the workplace is to a significant degree frustrated by the Government's policy goal of ensuring that financial advice is provided according to FSA rules.

9.20. We recommend that the Government, in co-operation with the FSA, take action to resolve this conflict of policy goals in order to facilitate the provision of financial advice by employers and make clear the basis on which employers may provide advice, without lowering standards.

9.21. A huge variety of products is available in the private pensions market, provided by a large number of suppliers, but we received evidence from a number of witnesses to suggest that this variety does not necessarily ensure adequate access to appropriate savings instruments. The Consumers' Association drew attention to the conclusion of the Sandler report that competitive forces in this market do not always work effectively to deliver value (Q465).[105] Professor David Blake pointed out that there is a trade-off between cost and choice. The multiplicity of personal pension schemes means that they cannot reap economies of scale, and thus on average their annual administrative costs are four times higher than for a typical final salary occupational pension scheme, and 14 times higher than the state pension scheme (Q225).

9.22. Professor Blake further argued that the choice offered by many pension schemes is the wrong sort of choice. Suppliers tend to offer choice about the internal structure of a pension plan, such as the type of fund in which to invest, whereas the key choice, in terms of the ultimate value of the pension, is over what rate of contribution to pay into the scheme (Q226).

9.23. The Consumers' Association suggested that collective pension schemes, such as the industry-based schemes that are common in the Netherlands, or the US Federal Thrift Savings Plan, could provide a more efficient and appropriate mechanism for personal pension saving, especially for low income individuals, than existing products available in the United Kingdom (including stakeholder pensions) (Q478).

9.24. We note that some progress is being made towards the development of a suite of "simple and comprehensible" long-term saving products, as recommended by the Sandler review.[106] However, an additional barrier to higher levels of private pension saving is the loss of trust in private pension providers that has resulted from the recent decline in equity values, a number of mis-selling scandals, and the collapse of Equitable Life (Q 261-2, 460).[107]

9.25. We believe that there is a role for Government in providing a simple, secure and guaranteed long-term savings instrument which can be used by lower-income individuals who do not wish to expose themselves to the costs and risks involved in purchasing a commercial pension product. We recommend that the Government provide such a product, in the form of a pensions bond with a real rate of return linked to the economy-wide growth rate and administered by National Savings.

9.26. Better information, and better access to appropriate saving products, will help individuals develop coherent long-term saving strategies only if they can make sense of the information they are given. Many people appear to have quite unrealistic expectations of their pension future. A survey carried out by the Consumers' Association in 2002 found that on average respondents wanted to retire at 58 on a pension equal to three-quarters of their final salary, yet 46 per cent of them were not contributing to a pension at the time of the survey.[108] The FSA noted that most of the population find long-run financial planning "incomprehensible and deeply dull" (Q866). Although this attitude is in some cases the result of financial illiteracy, many otherwise financially literate people prefer to postpone any serious consideration of pension savings until middle age. As the example in Box 3 shows, such a decision has a huge impact on the required contribution rate.

Box 3

Required contributions into a pension scheme

The contribution rate required to generate any given level of pension rises steeply with the age at which saving begins, for two separate reasons. First, if contributions are postponed, there are fewer years of contribution available to finance a given period of retirement. Secondly, contributions accumulate compound interest for a shorter period of time.

The following example has been provided by Professor David Blake, and is based on a model in which a defined-contribution pension of two-thirds of final salary is provided at age 65.[109]
Starting age25 354555
Male contribution rate (% of salary) 172437 72
Female contribution rate (% of salary) 192742 84

The required contribution rate (as a percentage of salary) is higher for women than men, because women have a higher life expectancy at age 65, and thus need to accumulate a larger capital sum to support a given level of pension.

This example is based on the plausible assumption that the long-run rate of growth of real earnings is 2% p.a., and the rate of real return on assets is 3% p.a. Small changes in these assumptions would alter the required age-specific contribution rates, but would have little impact on the relativities between contribution rates at different ages.

9.27. A further barrier to increased pension saving is that pension products are inflexible, since they offer little or no liquidity during the accumulation phase; thus they diminish the opportunity for flexible financial planning during the working phase of the life-course. Since taxation of pensions is broadly neutral, the incentive to save via a pension product rather than, say, an ISA, is slight. Continuing change to historic patterns of household formation and dissolution (noted in chapter 8 above), together with the further development of labour market flexibility, increase the potential cost to an individual of allocating a major part of total financial savings to a product that cannot be accessed until some fixed date in the future.

9.28. A number of witnesses argued that, given these problems relating to information about, access to and public understanding of long-term pension savings, it is unlikely that the scale of voluntary pensions savings will rise at the rate desired by the Government, and that therefore compulsion would be necessary (Professor Blake: QQ 214-5); Consumers' Association: Q471; Equal Opportunities Commission: Q487). Other witnesses, while often recognising the barriers to more extensive voluntary pension provision that exist within the United Kingdom pension regime, strongly opposed compulsion. Mr Gordon Lishman (Managing Director, Age Concern) noted that compulsion is "a blunt instrument" which might adversely affect young people who could be better served by paying off debt or investing their disposable income in developing their qualifications (Q317). Professors Booth and Disney noted that there is a strong economic argument for enough compulsion to take an individual off means-tested benefits, since otherwise non-savers can deliberately impose the cost of their non-saving on others (that is, taxpayers), but that there is little economic sense in imposing compulsion beyond that point (Q821).

9.29. Professors Booth and Disney also suggested that discussion of the role of compulsion in pension savings should not focus on issues of principle, but on details of practice, since the United Kingdom already imposes compulsory pension savings on all contributors to the National Insurance system. These contributions (to the basic state pension, and to either the state second pension or to an approved contracted-out pension scheme) currently amount to around 8 per cent of earnings (Q821).

9.30. The Secretary of State for Work and Pensions agreed that there already exists "significant compulsion in the system", but he also expressed the view that further compulsion should not be viewed as a panacea for the perceived problem of under-saving (Q1113). He pointed out that the Government had appointed an independent Pensions Commission, chaired by Adair Turner, to monitor the scale of voluntary pension savings, and to determine whether there might be a case for moving beyond the present voluntary system.

9.31. We are concerned that current levels of voluntary pension saving in the United Kingdom are too low to generate the levels of retirement income that working people say they expect to receive in the future, and we recognise that more compulsion could help to close this savings gap. On the other hand, we recognise the force of the argument that compulsion distorts the market, and imposes unnecessary costs on some individuals. Given the high and growing degree of means-testing among the pensioner population, we think it likely that an extension of compulsory pension savings might particularly disadvantage lower-income individuals who would receive extremely low returns from their additional pension saving.

9.32. On balance, therefore, we conclude that a general extension of compulsion in pension savings should be avoided. However, that requires the Government to take action to provide a higher minimum state pension. We discuss this issue further in chapter 10.

Uncertainty and private pensions

9.33. We received a considerable amount of evidence relating to the growing degree of uncertainty surrounding the outcome of private pension saving. This concerns us for two reasons. First, uncertainty of outcome is likely to make individuals less enthusiastic about committing their long-run savings to a pension scheme; thus uncertainty tends to exacerbate the problem of under-saving. Secondly, uncertainty of outcome in the private pension sector indirectly places a greater burden on the state pension to provide a guaranteed income in retirement.

9.34. The uncertainty of defined contribution private pension outcomes has become more obvious in recent years because of the sharp decline in equity prices and adverse movement in annuity rates. This uncertainty is exacerbated by the separation of the accumulation and decumulation phases of a private pension: the accumulation phase is frequently undertaken by a different company from that which manages the decumulation phase via the sale of an annuity (QQ208, 726).

9.35. We note that some of the popular concern about the recent decline in annuity rates fails to appreciate that this is in part the inevitable result of the welcome improvements in life expectancy at older ages discussed in chapter 2 above. Furthermore, some of the concern derives from "money illusion": annuity rates would be higher if inflation and nominal interest rates were higher, but annuitants would be no better off in real terms. The Government's success in generating an economic environment of low and stable rates of inflation and interest is, in general, beneficial to the pensioner population, since low inflation preserves the capital value of savings.

9.36. We recognise, however, that popular concern about the uncertainty of investment returns and annuity rates is compounded by a widespread lack of trust in the financial services industry. Mr John Hawksworth (PricewaterhouseCoopers) explained that many people "feel they have been sold things so someone can make commission, so that somebody can meet their sales target for the month rather than because there is any kind of commitment to actually delivering the product" (Q262).

9.37. We believe that the financial services industry needs actively to rebuild a relationship of trust with purchasers of its products, and that in so doing it should seriously analyse the extent to which trust and consumer confidence can be made compatible with commission-based selling. As noted in paragraph 9.18 above, we believe that consumer confidence in pension products would be increased if advice on these products could be delivered more effectively through the workplace. We note, however, that workplace-based advice cannot reach that large number of adults, primarily women, who at any one time are not engaged in paid employment (Q487). We recognise the merit of the suggestion by the Consumers' Association that such persons might best be served by a community-based national financial advice network (Q461).

9.38. We recommend that the Government explore with the voluntary sector and the financial services industry the possibility of developing a national financial advice network for low-income individuals.

9.39. Defined benefit occupational pensions can provide more secure pension outcomes than defined contribution schemes, because the employer carries much of the downside risk of inadequate investment returns. However, it is clear that many employers have already decided to limit the extent of this risk by closing their defined benefit schemes to new members, or by winding them up. Evidence from the Engineering Employers' Federation, the National Association of Pension Funds, and the Actuarial Profession indicated that an important factor has been regulation which has converted what were hitherto discretionary benefits relating to indexation and survivors' pensions into guarantees. This regulation, while providing improved benefits for members, has served to increase the cost to employers of providing defined benefit pensions by anything up to 40 per cent, and has removed from them discretion over the level to which they fund their pension scheme (QQ 592, 642, 665, 943).

9.40. Opinion is divided as to whether there is a future for defined benefit occupational pension schemes. One view is that a growing perception among shareholders of the cost of defined benefit pensions, and among managers of the slight advantages such schemes convey in terms of retention and recruitment, means that the drift away from defined benefit pensions will gather speed. Mr Ronnie Bowie (Senior Partner, Hymans Robertson), giving evidence on behalf of the Actuarial Profession, was of the opinion that that recent decisions by the Government to further restrict employer discretion over the winding-up of schemes would seal the fate of defined benefit pensions (Q943). Mr Terry Faulkner (Chairman, National Association of Pension Funds) reported that in a recent survey of 255 finance directors, 41 per cent reported that their final salary defined benefit pension scheme had been closed to new members in the last year, and that only around one fifth of such schemes are now open to new members (Q642). He thought that many more defined benefit schemes were likely to close in the future, particularly now that internal decisions about company pension schemes are driven more by issues of corporate finance than those of human resource management (Q643).

9.41. An alternative view, proposed by the Government, is that a reduction in regulatory and compliance costs will stimulate growth in employer provision. The Secretary of State for Work and Pensions told us that the Government's proposed simplification of the taxation and regulation of occupational pensions would "encourage companies to continue running good schemes and to start new schemes" (Q1113). He further pointed out that a "good" occupational pension scheme could equally be based on the principle of defined contribution or defined benefit (Q1109).

9.42. We conclude that the proposed reform to the regulatory and tax environment of occupational pensions will come too late to reverse, or even stem, the tide of closure of defined benefit pension schemes.

9.43. This concerns us, because, as noted by the Secretary of State for Work and Pensions, many employers use a shift from defined benefit to defined contribution pensions to reduce the level of their contributions to the pension scheme (Q1109).

9.44. We further conclude that the closure of defined benefit pension schemes seems to be associated with a reduction in overall pension savings, which will have the effect of reducing the value of future pension entitlements.

Actuarial Profession, volume II, p 340 Back

94   DWP, Simplicity, security and choice, p 156 Back

95   WBG/Fawcett Society, volume II, p 133; EOC, volume II, p 178 Back

96   TUC, volume II, p 115 Back

97   Association of British Insurers, volume II, pp 247-8 Back

98   Consumers' Association, volume II, p 163 Back

99   Ibid Back

100   Actuarial Profession, volume II, pp 340-1; p 344 Back

101   DWP, Simplicity, security and choice


102   DWP, Simplicity, security and choice, p 71 Back

103   Consumers' Association, volume II, p 163-4 Back

104   DWP, Simplicity, security and choice, p 73 Back

105   Ron Sandler, Medium and Long-Term Retail Savings in the UK: A Review (HM Treasury, 2002) Back

106   DWP/Treasury, Proposed product specifications for Sandler "stakeholder" products: Consultation document (February 2003) Back

107   Actuarial Profession, volume II, p 341 Back

108   Consumers' Association, volume II, p 163 Back

109   Professor Blake, volume II, p 60 Back

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