Testing times for mean pension

The Department for Work and Pensions\' report on means-testing has been met with a mixed response, as industry experts have criticised its process, the assumptions it has made and the value of the conclusions it has drawn from its analysis. Whether its findings will act as an encouragement to low earners to save in pension schemes remains is debatable.

Secretary of state for work and pensions James Purnell says that this report makes clear that for virtually everybody, if the benefit system remains the same, saving will make them better off in retirement. For over 95 per cent, on standard assumptions, the expected increase in income is greater than the cost of their contributions, even after taking inflation into account, he adds.

Critics say this is not much of a boast, and that even that 95 per cent figure requires the government’s assumptions on investments and annuity rates to be bang on, which of course the chances are they will not be. Dr Ros Altman, the independent pensions consultant, who has branded the report a whitewash, points out that the uncertainty of annuity rates is totally ignored and individuals are assumed to take an 80 per cent exposure to equities which achieves a 5.1 per cent above inflation rate of return. She adds that the employer’s contribution is treated as a tax that goes into the pension fund but is not part of workers’ pay, even though pay negotiations will doubtless reflect the increased burden on employers. “If a pension company made these claims, it would be in breach of the law under FSA rules,” says Altmann.

Altmann’s conclusion is shared by the independent Pensions Policy Institute, albeit in slightly less colourful language.

“The Government’s conclusion that most people can expect to be better off in retirement by saving, with the majority getting back more than double what they save needs careful interpretation,” says Niki Cleal, director of the PPI. “This finding is based on a specific set of assumptions which may, or may not, transpire in the real world. All individuals who save in money purchase pension schemes are exposed to the risk that the value of their pension pot can go down as well as up.”

Perhaps more useful would have been a stochastic approach, as used by many corporate intermediaries and pension providers, that would have shown the range of likely outcomes, although this would of course show a possibility that a larger group could lose out.

John Lawson, head of pensions policy at Standard Life believes the government needs to make clear its intentions on means-testing, which he believes would clarify the issue at a stroke. He says: “The truth is that the next generation will be unable to afford the taxes to support the same level of generous means-tested benefits when the baby boomers retire and a less numerous generation replaces them in the workplace. The Government should signal now that means-tested benefits will be scaled back and that it expects current workers to save for their own future.”

Whether the Government will have the appetite to do this, though, has more to do with the short-term nature of politics than the desire to send a clear message on savings. Provided the press do not turn against personal accounts when they are introduced in three or four years time, it will suit the DWP to ignore industry claims and watch apathy and the hope of better returns lead today’s unpensioned to remain opted in – many of them paying through their personal pensions for the state benefit they would have got. Provided there is not a mass opt out, this probably seems a more appealing solution to ministers than stating now that they are effectively going to introduce pensioner poverty at some time in the future.

Gauging public opinion will be crucial. It will be a brave personal finance journalist who tells people not to save in a pension, particularly where there is an employer contribution. But on the other hand, for older savers in particular, whatever this DWP report says, the maths doesn’t look great for saving.

Of more resonance to employees on low incomes may be the DWP’s written answer to a question posed by Baroness Hollis last summer. Then the DWP stated that someone on £10,000 a year would only be £2 a week better off in retirement after spending two decades paying into personal accounts.

Even somebody on £25,000 a year, more than the average UK wage of £23,700, will only increase their income in retirement from 30 per cent of salary to 31 per cent after 10 years in personal accounts, according to the DWP’s written answer.

The fact that, for older savers in particular, they stand to receive this income for many years longer than they paid into personal accounts may be lost on them when they come to make their decision on whether to remain opted in. Many argue the DWP still has work to do to make pension saving attractive.