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Last Updated: Monday, 16 January 2006, 06:57 GMT
Critical year ahead for pensions
By Julian Knight
BBC News personal finance reporter

A pension protest
Will we see more pension protests in 2006?
It may only be a fortnight old but 2006 is already shaping-up to be another difficult year for pensions.

In recent weeks, major employers, including the Co-op, Arcadia, Provident Financial and Rentokil have cut back on their pension provision.

Employees in these firms face a grim start to 2006, either paying much more into the workplace pension or seeing their final salary pension scheme mothballed by their employer.

This has brought the pensions crisis home for thousands of UK workers.

"The concern is that we could be seeing a domino effect going on with pensions... with one employer cutting benefits after another" Malcolm McLean, chief executive of the Pensions Advisory Service, told BBC News.

Yet the latest figures from the National Association of Pension Funds (NAPF) suggest that the rate of closure of final salary pension scheme has slowed during the past eighteen months.

The biggest question is, does the government believe it can afford to pay a bigger better state pension?
Malcolm McLean, Pensions Advisory Service

But this can be explained by the fact that so many final salary schemes were either closed to new members or closed altogether between 2000 and 2004, so much so that there are so few active schemes left.

Potentially, as far as final salary pension provision in the private sector is concerned, vanishing point could be reached in 2006

"It seems to me the only thing keeping some firms from winding their pension schemes up is the costs associated with making good the scheme deficits," Mr McLean said.

Reform agenda

Last November when the Pensions Commission published radical proposals for reform of the way that Britain funds retirement, there seemed a route map out of the crisis.

In a 400 plus page report the Commission called for:

  • Increase the state pension age for men and women to 66 by 2030, to 67 by 2040, and to 68 by 2050, however if life expectancy races ahead the pension age may have to rise to 69 by 2050
  • Make the state pension more generous and link future increases in it to earnings rather than prices
  • In future, entitlement to the state pension should be based on residency rather than national insurance contributions
  • Automatically enrol people into a new low-cost government-administered savings scheme
  • Give people the chance to opt out if it's not suitable for them.

Even before publication of the report, the government promised to issue a white paper in the spring.

GUIDE TO UK PENSIONS
Facts and figures outlining the depth of the UK pensions crisis

"The issues are huge but the biggest question is, does the government believe it can afford to pay a bigger better state pension?" Malcolm McLean said.

"Everything flows from this, cutting back on means testing to encouraging a higher level of private saving," he added.

However, in the run up to the publication of the Pensions Commission report, Treasury officials busied themselves pouring cold water on the central idea of an enhanced state pension.

They suggested that the Commission's proposals were too costly and unworkable - the equivalent of being blackballed.

Yet, subsequently, the mood music emanating from number 10 has suggested that the Pensions Commission report has greater legs than was presumed at the time of publication.

How much of the Pensions Commission's report filters through to the white paper has the potential to become a tug of war between the incumbents of number 10 and number 11 Downing Street.

A lot now rests on the shoulders of Work and Pensions Secretary John Hutton, who took over from David Blunkett in November.

Under fire

John Hutton
John Hutton, Work and Pensions Secretary, has a lot to think about

It is not just the Pensions Commission's proposal to reform the state pension that has drawn fire.

Many insurers are against the idea of enrolling people into a national savings scheme.

Cynics have suggested insurers are worried about the prospect that the savings scheme is designed to be far cheaper than personal pensions that they make millions of pounds from selling.

It is widely recognised that the savings scheme, if it gets the go-ahead, has the potential to kill personal pension sales stone dead.

But not all objections are rooted in self interest.

The NAPF is concerned that the savings scheme could have a detrimental effect on workplace pension provision.

At present on average companies which offer their workers a final salary pension contribute 17% of salary.

But the new national savings scheme envisages an employer contribution of just 3%.

The NAPF said this prompts the question: Why should employers contribute 17% of salary when some of their competitors are paying just 3%?

Christine Farnish the chief executive of the NAPF accused the Commission of being "too complacent over the potential levelling down impact on workplace schemes."

Simplification

But 2006 is not set to be all doom and gloom for pensions.

Lots of people are put off pensions by the requirement to buy an annuity, end this requirement and you make pension saving more appealing
Sarah Windsor-Lewis, Punter Southall Financial Management

In April reforms designed to simplify pension saving come into force.

For starters, the complex, age based, formula limiting pension contributions to a certain percentage of income is being swept away.

Instead, whatever the age of the contributor, it will be possible to invest 100% of annual income, up to a maximum 215,000, in a pension and receive tax relief.

"This could be a big help in encouraging people in their forties and fifties who don't have a pension at present," Sarah Windsor-Lewis, principal at Punter Southall financial management, said.

"Under the present rules, it is often not worthwhile someone in their forties or fifties starting a pension.

"They simply are unable to save enough - within the strict age and income limits - to secure a big retirement income.

"But this will all change from April when it will be possible for someone to build a substantial pension up in little time...provided they have enough money to pay in," Ms Windsor-Lewis added.

In addition, from April savers will no longer be forced to use their pension pot to buy an annuity income by age 75.

Instead pension holders will have the option to draw an income direct from their retirement savings pot rather than converting it into an annuity.

Annuities are a much criticised product.

They are seen by some as being inflexible and offering a poor deal.

"This is good move...Lots of people are put off pensions by the requirement to buy an annuity, end this requirement and you make pension saving more appealing," Ms Windsor-Lewis added.


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