Automatic enrolment is the government’s new policy to ensure that every tax-paying employee is automatically put into a pension scheme at work, with their employer contributing to their pension as well.
Even working mothers must set up a pension scheme for their nannies. Staff can opt out, but many will not bother.
This reform aims to deliver better private pensions to top up the state pension, which will be reduced for future pensioners after 2016.
Currently, state pensions have two parts: a flat-rate basic pension and an earnings-related second pension. In future, the second pension will be abolished, leaving just a flat-rate state pension of around £144 a week.
This is sensible. People appreciate the need to save, to have more than the state minimum and to stop the current system’s means-testing penalties on private savings.
Private pensions from auto-enrolment will need to fill the void of the earnings-related part of the state pension as well as offering extra income to ensure future pensioner living standards are above just a basic minimum. This requires good products that help people build up good pensions.
Yet, most new schemes carry significant risks for employees.
Unlike traditional company schemes where employers shouldered the risks of providing good pensions, these new so-called “defined contribution” schemes place the risks and responsibility onto the workers themselves. All the employee knows is how much money they and their employer put in.
This leaves individuals facing significant risks when building up their fund and choosing the right options for converting it into a pension income at retirement.
Both these elements are vitally important, but neither is working well enough to cater for the retirement needs of the future. More flexible products and financial planning advice would help deliver better pensions. My concerns about auto-enrolment pension inadequacies are highlighted in my latest research report, which was sponsored by MetLife,Pensions: Time for change
Fascinating results from surveys carried out for this report shows how people’s attitudes to old age and retirement are radically changing. Rather than retiring at the traditional age of 65, the majority intend to work longer, partly because they want to, but also because inadequate pension provision means they need to. However, the standard investment funds offered for people’s pension savings are designed for a world where people stop working altogether at age 65.
Pensions are about people, not just about money, so pensions need to fit future developments in people’s lives, rather than trying to shoehorn everyone into products that suit the past.
Today’s standard pension products prepare people for buying annuities at retirement, but this is not necessarily appropriate for the future either. Annuities have become terrible value for many purchasers. Forcing people to commit their whole pension fund to buying one irreversible, inflexible product at a relatively early stage of their retirement is unlikely to optimise the value of their pension savings.
An annuity involves giving your pension fund to an insurance company, which then promises to pay a small amount of your money back each month until you die. If you outlive your fund, the insurer will keep paying out, supposedly using money from those who died before their pension fund was exhausted to subsidise the payments to those who live longer. However, annuity rates have fallen so low recently that the customers funds will now often not run out before they reach their late 90s. This means the insurance element of annuities will hardly ever pay out.
Additionally, standard annuities do not cover most of the risks people are likely to face during their retirement. They offer no inflation protection, no provision for a partner, nothing to help pay extra costs if you become ill or need care and no money passes on if you die young. In addition, once their pension fund money has been handed over, customers can never benefit if rates rise or markets do well. Pensions fit for the future need to address all these risks.
As auto-enrolment proceeds, it is time to change the way pensions work, to make them fit better with people’s future lives. After all, that is what pensions should be about.
Dr Ros Altmann is a former government policy adviser on pensions (www.rosaltmann.com)
