CHAPTER 9: AGEING AND RETIREMENT II: PRIVATE
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.
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).
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
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
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.
The saving capacity of people on relatively low incomes is also
likely to be limited.
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
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.
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.
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.
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
- 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.
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
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
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.
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
9.17. A further barrier to private pension saving
is a perceived difficulty in obtaining unbiased financial advice.
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.
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
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
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.
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
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.
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.
Required contributions into a pension
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.
|Male contribution rate (% of salary)
|Female contribution rate (% of salary)
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
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
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
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.
93 Actuarial Profession, volume II, p 340 Back
DWP, Simplicity, security and choice, p 156 Back
WBG/Fawcett Society, volume II, p 133; EOC, volume II, p 178 Back
TUC, volume II, p 115 Back
Association of British Insurers, volume II, pp 247-8 Back
Consumers' Association, volume II, p 163 Back
Actuarial Profession, volume II, pp 340-1; p 344 Back
DWP, Simplicity, security and choice
DWP, Simplicity, security and choice, p 71 Back
Consumers' Association, volume II, p 163-4 Back
DWP, Simplicity, security and choice, p 73 Back
Ron Sandler, Medium and Long-Term Retail Savings in the UK:
A Review (HM Treasury, 2002) Back
DWP/Treasury, Proposed product specifications for Sandler "stakeholder"
products: Consultation document (February 2003) Back
Actuarial Profession, volume II, p 341 Back
Consumers' Association, volume II, p 163 Back
Professor Blake, volume II, p 60 Back