How low can they go?

Figures revealing just how little low and average earners will get from personal accounts threaten to undermine the idea of pension savings across the board. John Greenwood reports

The full extent of the disincentive to save for low earners has been laid bare by a shocking set of figures released by the Government last month. In a nutshell, millions of workers will only see their retirement income increased by 1 per cent by saving in personal accounts for up to 20 years.

These startling statistics come from Baroness Hollis, a Labour peer who was Parliamentary Under-Secretary of State at the Department for Work and Pensions from 1997 until 2005. After eight years at the DWP she clearly knows where the bodies are buried and the written answer to her latest question should surely push the debate onto new ground.

While the Personal Accounts Delivery Authority has been agonising over which charging structure will offer the least detriment to savers, the bigger issue of the corrosive effect of means testing now looks set to take centre stage with the publication of these damning statistics.

Baroness Hollis asked what the effect of saving in personal accounts would be for to those with low to median earnings who were in line for full basic state pension and 30 years state second pension saving. For anyone earning £25,000 or less in personal accounts for 10 years, the effect of means testing results in only a 1 per cent increase in income in retirement, despite having foregone 4 per cent of earnings for that period.

Even after 20 years in personal accounts, people on £10,000 a year will still only increase their income in retirement by 1 per cent, while those on £15,000 and £20,000 will increase theirs by 2 per cent. People on £25,000 a year, actually more than the median full time earnings of £23,765 for 2007, will see their two decades of saving return them a handsome 3 per cent boost in income, taking them up to £162 a week pension, or 34 per cent of earnings.

Tom McPhail, head of pension policy at Hargreaves Lansdown says: “The worrying aspect to these figures is that for people with less than 20 years to go until retirement there is only a very marginal benefit from saving in a pension where that saving is in line with the personal account default rates.”

Obviously there are caveats with this. Some people will retire later in life, and many people’s pots will be so low that they will be able to take advantage of the trivial commutation rules.

“But the bottom line is it appears that it is highly questionable whether someone aged over 50, earning £25,000 or less, who doesn’t already have private pensions and who is only going to save at the default rates, should sign up for personal accounts. If they can afford to save, then they should probably put the money in an Isa,” says McPhail.

“In many respects Baroness Hollis put in a stonking question and got an incredible answer,” says Alasdair Buchanan, group head of communications at Scottish Life.

So if these figures are so bad for people in personal accounts, what does it mean for employees in existing pensions? Does this mean that employers are wasting their money offering pension plans that will ultimately give very little benefit to staff when they retire?

“To see the figure in terms of a percentage is very surprising. This will open up the debate between the differences between personal accounts and private sector arrangements,” says Buchanan. He points to the fact that personal accounts only kick in after a £5,000 disregard has been taken into account. “For low earners this really wipes out their chance of an increase in income, yet these are the people who need personal accounts most,” he says.

For many middle earners saving through workplace pensions today an 8 per cent combined contribution is not uncommon. They will be surprised to learn they may only be boosting their retirement income by 2 per cent. So what should advisers be telling them about these figures?

“For many people their combined S2P and basic state pension will take them above the means testing income limit of £167 a week, but for those on low incomes who are 50 or over, who haven’t got pension income from other sources, you have to question whether it is worth their while staying put in today’s pensions or whether they should move into an Isa,” says McPhail.

The Conservatives, whose resurgence in the opinion polls is giving their views more significance by the minute, have recently been saying that the consensus on personal accounts is only worth keeping if the issues of the incentive to save is properly addressed. The Tories have said they want to make sure that Otto Thoresen’s ‘Money Guidance’ actually protects individuals from saving for nothing, before they will back personal accounts all the way to the finishing post.

But with outcomes like those identified by Baroness Hollis facing millions in the target market, the success of ‘Money Guidance’ is by no means assured.

In the words of McPhail: “We pensions professionals have difficulty figuring out what the disincentive to save actually is. And the government thinks a simple Money Guidance service will get the public through this maze?”