Defined ambition is not going to solve the low contribution rates that are the real problem with DC says Teresa Hunter
How does it go? “Holding back the tears, ’cause nothing here has grown.” It certainly applies to the world of pensions, where the position of those working in the private sector just gets worse, particularly if they are relying on defined contributions arrangements.
Many are blissfully ignorant of how poor their position may be at retirement. As my actuarial friends are fond of reminding me, we have yet to see a significant generation retire on defined contribution pensions. But that will soon change.
According to the National Association of Pension Funds, there are some 750,000 aged between 60 and 65 with money purchase schemes. Hard on their heels are 2.2m in their 50s.
And if the bomb doesn’t go off when these individuals retire, there are 3m currently in their 40s, who will be relying probably entirely on a DC occupational schemes.
So it is understandable that Webb wants to erect a bomb shelter to protect the Government and his legacy from the fall-out, by floating the idea of some new form of guarantee for private sector workers. Then, when public anger explodes, he can point his finger at employers and say “we told you so”.
If anyone deserves to go down in history as a great pension reformer in the Liberal tradition, it should be Webb. Getting a higher, universal pension off the ground will hopefully prove to be a stroke of genius. Sadly his legacy will also included auto-enrolment, which offers yet another guarantee, that of more trouble in the making.
But could his new defined ambition pension solve the problem? He has three suggestions. Employers guarantee a lump sum at retirement, leaving the employee to shoulder the annuity and longevity risk. Alternatively, they guarantee a level of pension, provided investments achieve a certain benchmark of performance.
Finally, employers could guarantee a pension but at a much later age, such as 70 or 75, again cutting longevity risk.
The consensus is that having already been burned by Government avarice and regulation, most employers would run a mile.
From the employees’ perspective, it offers reassurance, but reassurance as to what? It would put a floor under their downside risk, but at a very low level. In other words, we could be locking in poor pensions. The average employer contribution, according to the Association of Consulting Actuaries, is between 4 per cent and 8 per cent, with employees contributing between 3 per cent and 5 per cent of earnings. Overall, combined contributions average around 10 or 11 per cent.
But absolutely everyone, from employers to their advisers and the Department of Work and Pensions knows you have to pay 20 per cent of your salary into a pension for 40 years to have any hope of providing a decent pension. The only ones left out of the secret are employees, who are sleepwalking to disappointment.
Webb could achieve more by forcing employers and staff to double their contributions. Get the contribution levels right, and a return to some form of risk-sharing, has to be a good thing. Advisers seem to think that the easiest pill for employers to swallow, would be the guaranteed lump sum at retirement.
A stumbling block is that these schemes already exist, but few employers have taken them up. Barclays staff enjoy a level of lump sum guarantee. At John Lewis the longevity risk is shared. This might become more of a possibility when the state pension age is automatically linked to rising life expectancy.
If Government was serious it would have to resort to compulsion, perhaps backed up with big tax incentives, even though employers would fight compulsion tooth and nail. And yes, pigs might fly. After all, auto-enrolment begins later this year.
Teresa Hunter is a freelance journalist