Annual savings of more than £1bn resulting from the abolition of contracting-out should be used to encourage private saving, rather than subsumed into general government revenues, says the Association of British Insurers.
In a paper: ‘The past, present and future of contracting out’, the ABI argues the decision to abolish contracting-out for defined contribution (DC) pensions in around 2012 leaves a “black hole” in the government’s expenditure forecasts for pension reform.
There is uncertainty at present as to how this ‘cashflow benefit’ will be used, but the ABI claims while some suggest the money should be used to improve current state pensions, there is “a growing consensus that this would be an inappropriate direct transfer of resources from the pension funds of working people to the current pensions of retired people”.
In the 19-page paper, the ABI admits it is “unclear how large the resulting cash-flow benefit will prove to be” from the move, as in the pensions white paper in May 2006 the Government quoted figures of £4bn for 2012/13 and £5.1bn by 2050.
But the paper points out in the subsequent Regulatory Impact Assessment on the Pensions Bill, “the cost of future rebates was cut by more than one-half and put at just £1.6bn for 2011”.
Despite this uncertainty the ABI has put forward three suggestions, which are not “mutually exclusive”, on how the resulting money can be used to continue to support private pension saving:
- Financial support for employers to help cover the cost of providing pension contributions – such as reducing National Insurance (NI) for employers who face particular challenges to help ensure existing schemes stay open and smaller employers can meet the additional costs of personal accounts;
- An on-going information campaign to highlight the value of employers’ pension contributions – it says millions of employees are not taking advantage of an employer’s pension contribution, so more needs to be done to inform them of the long-term financial consequences, and
- Extending the FSA’s workplace pilots - these seek to provide employees with enough financial information to make informed decisions about their savings behaviour over the long term, and play an important part in the campaign to increase financial literacy levels.
The paper argues there is currently confusion over how the government will respond to the extra cash-flow as in June 2006 John Hutton, the Secretary of State for Work and Pensions, said the proposal to abolish contracting out “does create some space now, which is necessary for the personal account scheme to be set up and to work.”
At the same time, he stated he wanted the money to remain in the pensions system and to be used to “embed and support a new savings culture”, possibly by funding the 1% tax relief for personal accounts.
However, the ABI says “contracted-out rebates have always been used to encourage private saving and to limit future state pension liabilities” so it argues abolishing contracting-out for DC schemes “might reduce administrative complexity, but it is important to ensure the cash-flow benefit is used to encourage private pension provision for future pensioners”.
Although it admits the “most likely outcome is that the extra revenue will be used to pay tax relief on contributions to personal accounts” as suggested by Hutton, the ABI argues this would be “inappropriate because tax relief is already an established part of the pensions system”.
In addition, it says research carried out for the government estimates up to 50% of the saving in personal accounts will be existing saving transferred from elsewhere which means using the contracting out savings to pay for tax relief would “represent a reduction in overall spending on pensions”.
The ABI argues: “Rather than using the NI rebates simply to oil the default contributions to personal accounts, it would be better to use the money on promoting and incentivising additional saving.”
“It is essential that the extra revenue is not subsumed within general government revenues. If that were to happen, then the abolition of contracting-out for DC schemes would cause a fall in pension entitlement.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7034 2681 or email [email protected]IFAonline
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