Compulsory or voluntary?

We are moving from a compulsory pensions system to a voluntary one. Unfortunately for them, many people will be offered rational reasons for not saving says Steve Bee, head of pensions strategy at Scottish Life

Firstly the rot that has set in to the Basic State Pension since the early 1980s will be stopped from 2012. Secondly, the State Second Pension (S2P) will eventually become a flat-rate entitlement and thirdly all employees not already in a good workplace pension scheme in 2012 will be auto-enrolled into pension saving.

The Government is introducing personal accounts and auto-enrolment to ensure that every employee in the UK will have access to a ‘good’ workplace pension scheme, with the workplace pension scheme called Personal Accounts as a default. In short, the personal accounts scheme will be the off-the-shelf scheme for employers who either can’t be bothered to run their own scheme, or don’t want to.

But at the moment we’ve already got a good workplace pension scheme for every employee in the UK; it’s called the State Second Pension (S2P). Not only that, but we’ve had an earnings-related state second pension scheme for all employees since 1961, nearly half a century ago.

In its heyday the state second pension scheme was called Serps, the State Earnings-Related Pension Scheme. Serps, when it started back in 1978, was a very generous scheme that aimed to provide a pension to members broadly equivalent to one eightieth of uprated average salary. It stacked up pretty well against the private sector pension schemes that the larger employers provided for their employees and was, in effect, an occupational pension scheme for employees whose employers either couldn’t be bothered to run their own scheme, or didn’t want to.

It has always been possible for employers to contract-out of the state-run second pension if their own schemes were of sufficient quality, but the bottom line has always been that in the absence of alternatives membership of the state-run occupational pension scheme has been compulsory.

That’s the big difference between the past and the future that we’re on the brink of today; workplace pensions for all employees have been compulsory in the past, but will become voluntary in the future. It’s not widely appreciated or understood, but the loss of value to private pension savings caused by the withdrawal of means-tested benefits also happens to the ‘value’ of S2P and Serps pensions too. It always has and the problem has worsened as the extent of means-testing for the elderly has spread, just as it has for private pensions and as it will for personal accounts. Hardly anyone knows about this, but even if they did there wouldn’t be anything they could do about it because membership of state second pension schemes has, since the early 1960s, always been compulsory; compulsion is compulsion.

But from 2010 the state second pension will begin to morph into a flat-rate top-up to the sadly inadequate basic pension. The compulsory earnings-related workplace pension scheme for all employees will become a thing of the past. It will be replaced by voluntary membership of existing workplace schemes or the default scheme of personal accounts. But the crude way that means-tested entitlements strip value from other pension savings will be left unchanged.

It’s not too hard to imagine why people given the choice in the full knowledge of the potential loss in value of their voluntary savings might in future choose not to save at all. Just as it isn’t hard to guess that if people in the past had been given the choice of paying a lower rate of national insurance they would have done so if membership of the state second pension scheme had been voluntary rather than compulsory.

The big change that’s about to be made is from compulsory workplace pensions for all employees to voluntary workplace pensions for all employees.

That switch from compulsory pension savings to voluntary pension savings seems wrong to me if people are at the same time presented with what for many of them will be entirely rational reasons not to save at all. With the anticipated future increases in mortality the current set of pension ‘reforms’ may well become something that many of our citizens may literally live to regret.