With people living longer yet failing to make sufficient provision for their retirement, the Government must act now to prevent the kind of social and financial crisis that has hit Japan
Pensions provision is the greatest problem the Government will face in the next 50 years. If current trends continue, the elderly will not be able to provide for their retirement and the Government will face a social and financial crisis, with an ageing, economically inactive population.
To put it simply, people are living longer than ever before, exceeding actuarial expectations, and the dependency ratio is beginning to grow. Simultaneously, they are not making sufficient provision for their retirement, leading to a growing savings gap. To complete this calamity, massive equity falls have severely eroded pensions funds, leading to significant shortfalls in the benefits paid out.
We are already seeing nations such as Japan suffer under the onus of excessive dependency, with many pensions schemes failing to fulfil their promises. Such problems in the Western world begs the question, what can the Government do to stop the pensions crisis?
Most of the Government's initiatives have focused on encouraging people to make sufficient private provision for their retirement. Indeed, much of this has concentrated on the production of low charge, low opacity products that should be more attractive to investors. The flagship product for this has been the stakeholder pension, which has been an unmitigated failure.
While stakeholder was designed to target low to middle income earners, take-up has been very low among these target groups. Instead, it has become a useful financial planning tool for high net worth investors who can use the no income rule to make pensions provisions for their wives and children. Indeed, the Government's drive to make employers with more than five employees offer stakeholder has not created the desired effect, with pensions take-up unaffected.
There is no doubt this failure is somewhat down to falling stock values and the negative attitudes towards equity-linked pensions provision. Nonetheless, the failure points to one simple fact: product efficiency and transparency are not drivers for pensions take-up.
It is ironic, therefore, that the Sandler Report put such a strong emphasis on product efficiency and lack of opacity to help reduce the savings gap. Indeed, the proposals for a new stakeholder suite of products seem to have been conceived without accounting for the stakeholder pensions experience.
Alan Pickering has followed a similar tack to Sandler, arguing that pensions simplification and the reduction of charges are likely to be drivers to more stable financial products and, therefore, higher take-up.
Pickering has argued for the reduction of pensions types to three generic products: a defined benefit group scheme, a money purchase individual scheme and a money purchase group scheme.
Such a simplification might be considered desirable to remove confusion among consumers but is unlikely to drive any great take-up of pensions.
It could also be argued that the removal of a variety of pension types, such as Sipps and SSASs, would reduce consumer choice and adversely affect their pensions options. It has also been argued that reducing charges and increasing competition in the pensions industry will result in consumers getting better value and better products. However, if charges fall too low, this is likely to prove a disincentive to product providers to offer pensions and they are likely to turn their hand to more lucrative financial products.
Faced with an ageing society, the Government may have to consider changing working practices, such as raising the retirement age for both men and women or allowing for semi retirement.
Another alternative is the introduction of compulsion on personal pension schemes in the private sector. If the population is economically active for a shorter proportion of their life, it will become increasingly necessary to use that economically active time to save for retirement. Such compulsion would be an immense boost to the financial services industry but is likely to take a lot of purchasing power out of the economy.
Equally, the tax-free status of pensions means the Government is likely to be adversely affected fiscally by such a move. This does not merely apply to direct taxation but to the potential lost VAT revenue from reduced consumer spending. Such a move could also prove politically unpopular among low to middle-income earners, who may find their standard of living badly affected.
That said, it is likely to appeal to government more than state funding of retirement through higher taxation.
However, such a visible increase in tax is likely to be unpopular with voters across the board.
The only other fiscally attractive options are likely to be even more politically contentious. Any future pensions reconfiguration would have to consider annuity reform. Although annuity rates have fallen dramatically, the equity-linked option of income drawdown and phased retirement does not look attractive in current market conditions.
The Government is currently aiming to increase competition in the annuity sector to improve annuity rates. Because annuities are compulsory, such competition is essential to improve product efficiencies and the rates available to consumers.
Minor adjustments such as changing the age limit for compulsory annuities could be used, along with increasing the availability of more impaired and limited life annuities. Equally, consumer awareness campaigns will be essential to improve annuity knowledge and understanding.
Charles Ansdell, corporate relations manager at Inter-Alliance
Product efficiency and transparency are not drivers for pension take-up.
Stakeholder a useful financial planning tool for high net worth investors using the no income rule to make pensions provisions for dependents.
Government may have to raise the retirement age or allow for semi-retirement.
Compulsion could pave the way to erosion of pension tax benefits.
The Government is currently looking to increase competition in the annuity sector to improve annuity rates.
The aviation sector's constant evaluation of errors in order to improve safety should be applied to defined benefit (DB) schemes, as too many are repeating the same mistakes again and again, research has shown.
IA sectors – help or hindrance?
Despite multiple complaints
Annuity market worth £4bn in 2017
For ‘distress’ caused