January 2008

Taking it personally

Are personal accounts an opportunity or a threat?

It depends on whether you perceive the mythical glass as half full or half empty. The worst case scenario is that employees opt out of personal accounts in droves and employers abandon their existing schemes en masse. Unless you are fortunate enough to be a public sector employee, pension provision over and above state levels would all but disappear, leaving people to survive on about £160 a week plus, of course, the rental income from all those empty buy-to-let properties upon which they based their retirement hopes.

That's a very bleak outlook and a catastrophe of that magnitude is extremely unlikely (I hope). The outcome will be somewhere between that worst case and, a slightly idyllic scenario, where all pensioners have a more than adequate income and means tested retirement benefits are a distant memory. Where we end up depends on the Financial Services Authority and the response to personal accounts of several different groups of people - employees and their employers, the pensions industry, IFAs, HM Revenue & Customs (HMRC) and the Department for Work and Pensions (DWP)).

What do the employees intend to do?

Recent research from Legal & General into people's attitudes towards personal accounts has revealed that nearly half would choose to stay in these accounts when they are introduced in 2012. Only a third of respondents said they would choose to opt out while one in five simply didn't know. The positive response was strongest among respondents for whom pensions have typically not been a priority, for example younger people and lower paid people. This is good news as it could indicate that personal accounts will prove complementary to existing pension markets. Having said that the high level on 'don't knows' indicates that the Government still has a considerable job to do in informing people as to how personal accounts work and how they will benefit individuals.

Do we need to set a sensible minimum contribution level?

Personal account contributions will be based on "band earnings" - these are currently earnings between approximately £5,000 and £35,000 a year. Contributions will be collected weekly from weekly paid employees. Although contributions will eventually reach 5% gross from the employee and 3% from the employer they will be phased in over three years. In 2012 the rate will start out at 1% gross from the employee and 1% from the employer.

Imagine that band earnings start at £5,200 a year in 2012 and we have an employee earning £101 a week. Contributions would be 0.8p a week from the member (the other 0.2p being tax relief) and 1p a week from the employer. The aspiration of a management charge of 0.3% per year of the fund would not pay the postage on the 'Welcome' letter! Without wishing to introduce further complexity, the stipulation of some minimum amount of earnings above the starting point of the band would ensure that only "meaningful" contributions were collected.

What about the contentious issue of auto enrolment?

Personal accounts will be the largest multi employer occupational pension scheme ever seen. As an occupational scheme it will be able to automatically enrol employees as members. The EU's Distance Marketing Directive prohibits automatic enrolment into group personal or stakeholder pensions which leaves employers running "good" existing pensions schemes out in the cold. Perhaps we need a more level playing field so that group schemes are not at a disadvantage?

What about the question of interaction with means tested benefits?

If individuals are to embrace personal accounts they need to be convinced that they are not replacing state benefits with their own money. The recent suggestion from the Pensions Policy Institute of a "pensions disregard" for pensions credit purposes is well thought out and a positive contribution to the debate. It seems unfair that an individual with no capital but a small pension should have that entire pension offset when an individual with £6,000 capital but no pension sees no effect on their state benefits.

How will decumulation work?

Government has already decided that the most suitable option for the vast majority of personal accounts members, who will have relatively small funds, is the purchase of an annuity.

The question is how do those individuals choose the best annuity for their own circumstances? The size of their funds makes the provision of advice uneconomic under the current regulatory regime. The Open Market Option Review proposes making much more information available to such individuals. Since Government has already decided that an annuity is the "right thing" for these people, what is the logic in the FSA insisting that advisers check that the product is "suitable"? A web-based guided "prescription" form to enable individuals to determine the best type of annuity for them must be a good idea. This could then be taken to an adviser who for, very little remuneration would find and transact the best annuity rate for them.

Clearly there are some very practical issues that have to be overcome before personal accounts are to be judged 'a good idea'. If we are to successfully make the journey to the wonderful fully pensioned Utopia we have to tackle the "practical" aspects of making personal accounts worthwhile for both employers and their staff.

John Gleadall
Senior Technical
Legal & General