A £3,000 contribution cap on personal accounts would be sufficient for most low earners - including the self-employed - to achieve a replacement rate in retirement of two-thirds of their final salary.
The latest briefing note from the Pension Policy Institute (PPI) looks at the issues surrounding the contribution cap for the new system of personal accounts after the Government suggested in its December white paper the cap should be £10,000 in the first year of operation, and £5,000 in each following year.
However, as this was higher than the £3,000 limit suggested by the Pensions Commission many parts of the industry have argued against the higher cap on the basis it would have a negative impact on existing pension provision.
But the research from the PPI reveals the level of contributions needed to achieve the desired two-thirds replacement rate in retirement will depend on an individual’s earnings profile and working history.
In addition, it points out the limit will also depend on the Government’s target market and its policy intentions for the new system, as it has previously stated personal accounts are designed for around 10 million people who don’t currently have access to a pension scheme with employer contributions.
Although the PPI adds while the Government has said low to median earners are the particular focus for the new system, it has predicted in its Regulatory Impact Assessment that around “14% of our target group for automatic enrolment into personal accounts will earn more than £30,000”.
As a result the PPI says if the Government intends personal accounts mainly as a product for low to median earners then a £3,000 cap would be sufficient, but if it also intends to target higher earners without access to existing provision then a £5,000 limit may be needed, although it admits this could impact negatively on the existing market.
The research reveals a £3,000 cap would be sufficient for a 25-year-old male in 2012 with a full working history, up until his earnings hit the 7th and 9th decile where even a £5,000 limit would constrain contributions.
However, a woman aged 25 in 2012 who has at least two caring breaks could reach the target replacement rate with a £3,000 limit if she is a low earner, but if she has medium earnings, she would need to contribute more than £3,000 in some years, which means the lower cap could limit her flexibility to save.
And the PPI reveals a median earning woman aged 40 in 2012 with caring breaks and no previous saving would need to save around £4,000 a year if she is to reach a target replacement rate.
Although the PPI points out in this case the woman would need to contribute almost 32% of her banded earnings each year, so it suggest affordability issues may be more of a barrier in this instance than the contribution limit.
As a result the briefing note highlights some possible alternatives to the contribution cap, including a lifetime limit – similar to the rest of the pensions market following A-Day – which would allow members the flexibility of making additional contributions when they are able.
And it suggests personal accounts could roll forward unused annual allowances into following years, while they could also allow one-off higher contributions from certain sources such as divorce settlements or inheritance.
The Government's response to the December personal accounts white paper, which is expected to include decisions on issues including the contribution cap, is scheduled to be published later this month.
Have Your Say: Graham Bowser, director of QS Financial Planning, says:
"And where are these low earners going to find £3000 pa? The reality is that most low earners will simply opt out and any limit is totally irrelevant to them."
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