MILLIONS of workers will have to retire later and save more, under wide-ranging reforms proposed by Lord Turner’s Pensions Commission last week.
The plans were unveiled only months before another radical overhaul of Britain’s pensions system takes effect.
On April 6 next year, dubbed A-Day, most savers will get more freedom over their pension contributions, with the ability to invest in assets such as residential property. And in May next year the government is due to publish a white paper on pensions in response to Turner’s report.
Turner, a former CBI director-general, who was appointed by the government in December 2002 to look into Britain’s creaking pensions system, found that between 9m and 12m workers were not saving enough for retirement. He said last week that the solution lay in a mix of working later and saving more.
His most controversial proposal was that the state pension age should rise gradually in line with life expectancy — but such calculations would not start until 2020. Turner suggested that it would then go up to 66 in 2030, 67 in 2040 and 68 in 2050. In return, people should get a more generous state pension that would rise in line with earnings rather than prices.
Turner also recommended a new, low-cost pension plan for millions of workers not in satisfactory occupational schemes. Nearly 1m companies do not contribute to a pension on behalf of employees, according to Scottish Widows, the insurer.
Workers would be enrolled automatically into the so-called National Pension Savings Scheme (NPSS), but have a right to opt out. Members would contribute 4% of their post-tax earnings (worth 5% after tax relief), while employers would have to top this up with a compulsory contribution of 3% of earnings.
However, Turner had little to offer the millions of people who are already members of generous final-salary or money-purchase pension plans. For them, A-Day will have a far bigger impact and many need to start preparing for that now.
We answer your questions on the Turner report and A-Day.
When will I be able to retire?
If the government accepts Turner’s proposals, which is far from certain, people who are now in their teens would have to work until they were 68 before they could collect their state pension.
Workers in their twenties at present would be able to retire at 67, while those under 40 would have to work until 66. If life expectancy continues to rise, by the end of this century the pension might not be payable until age 73.
The commission’s plans to link the state pension age to life expectancy would not affect anyone over 50 at present, because the changes are unlikely to come into force before 2020.
Some commentators have criticised Turner for not going far enough. The Institute of Actuaries believes that the state retirement age would have to rise to at least 70 in 2050 to make pensions affordable.
I am in a final-salary scheme. What does the Turner report mean for me?
There was both good and bad news in the report. While Turner recognised that final- salary schemes were the “gold standard” of Britain’s pensions system, he was silent on ways to arrest their decline. In 1995 there were 5.2m active members of final-salary schemes compared with fewer than 2m today, and numbers are still falling fast.
A-Day is likely to have more impact on members of final-salary schemes, especially on higher earners approaching retirement.
Under the new rules, there will be a lifetime cap on the maximum value of a tax-free retirement fund, set at £1.5m in April 2006 and rising to £1.8m by 2010. Anything above that allowance will be taxed at 55%.
To work out if your final-salary plan might be over the limit, assume that your fund is worth 20 times your expected retirement income. So a pension paying £75,000 would be deemed to be worth £1.5m.
If you think you might be caught out by the tax charge, don’t panic. You can register with the scheme trustees to protect your pension from the penalty — and you have three years from A-Day to do so.
A-Day also has some big advantages for members of occupational schemes, including final-salary schemes.
The government, like Turner, wants to encourage people to work beyond the normal retirement age, so from April 6 it will allow you to take benefits from your company scheme without having to give up your job — if the trustees permit it. You could take your tax-free lump sum at the age of 50, rising to 55 from 2010, without having to stop work.
And you will be able to take 25% of your additional voluntary contributions (AVCs) as tax-free cash.
Members of occupational schemes will also be able to take out self-invested personal pension schemes (Sipps) alongside their workplace plans, giving them freedom to invest in a wider choice of assets, including residential property.
My company does not pay into a pension on my behalf. Will that change?
Yes, if Turner gets his way. He proposes that all workers should be automatically enrolled into the NPSS, with the right to opt out.
If you stayed in, you would have to contribute a minimum of 4% of your post-tax earnings between £4,888 and about £33,000 (worth 5% after tax relief from the government), while your employer would have to pay another 3% — a total of 8%.
There would be a cap on further voluntary contributions of twice the minimum for an average earner — or about £3,000 in cash terms. Companies could opt out if they offered a pension scheme at least as good as the NPSS and into which workers were enrolled automatically.
About 6m people would be expected to join this scheme.
So should I be saving about 8% of my earnings towards my retirement?
Turner is at pains to point out that this is only a minimum. Someone on average earnings who made only the minimum payments could expect the NPSS plus their state pension to provide 45% of their earnings in retirement.
However, many people aim to retire on about two-thirds of their salary. To achieve that, people on average earnings and their employers would have to make total contributions of about 16%, Turner says. This is a good benchmark for how much you need to save for a decent retirement — and it is also the maximum you would be able to put into the NPSS.
Many commentators are concerned, however, that the 8% minimum will become the default position.
John Batting, chief executive of Punter Southall, the pensions consultant, said: “There is a danger that the Pensions Commission’s proposals will make the pensions crisis worse. The 8% contribution to the NPSS could become a standard rather than the minimum.”
Where would my money be invested under the NPSS?
Contributions would be collected through payroll and transferred into investment funds of your choice. Turner suggested that the NPSS might offer a range of six to ten ordinary funds with charges as low as 0.3% a year, as well as more racy funds with higher fees.
He was scathing about the impact of the pension industry’s high charges on our retirement savings. “With annual costs of around 0.3%, individuals would achieve pensions about 30% bigger than if they had to pay the charges of, say, 1.3% that are typical for personal pensions today,” he said.
The NPSS would also have default funds for people who did not want to choose their own. Turner suggests a “lifestyle” fund that has a heavy weighting in equities while workers are still young, but which shifts into bonds as members approach retirement.
Simon Fraser of Fidelity International, which offers lifestyle funds in this country and is also the biggest provider of the equivalent of employer-sponsored group personal pensions in America, said: “Many money-purchase schemes are maturing at the moment in the US, and our experience there can inform debate in the UK.
“There, many members went for the default option, which was often cash, and are now having to work longer because they cannot afford to retire. We think it is right that the default option should include some exposure to equities.”
Members of the NPSS would have their own, individual pension pot, which they could move with them when they changed jobs. The funds would have to be used to buy an annuity on the open market eventually, but Turner thinks that the age at which you must do this — at present 75 — should rise in line with life expectancy.
I am in my company’s money- purchase scheme. What would Turner mean for me?
With money-purchase schemes, also called defined-contribution schemes, the worker and employer make payments into a fund and the worker’s pension depends on the performance of the underlying assets.
Members of money-purchase schemes contribute on average 9% of their earnings, with 6% from the employer and the rest from the worker, according to the Turner report. This is in excess of the minimum for NPSS, so most employers would be able to opt out of Turner’s proposals.
However, some commentators think companies will be tempted to close their schemes and fall back on the NPSS minimum to cut costs. Adrian Waddingham, chairman of the Association of Consulting Actuaries, said: “Faced with running a high-cost company scheme alongside a low-cost National Pension Savings Scheme, how many employers will feel it’s logical to close the company scheme on financial and administrative grounds? This would be a disturbing outturn.”
Fraser does not agree. He said: “We think that the thrust of Turner’s report was to continue to encourage good employers that offer quality pension schemes. Defined-contribution plans will continue to offer more flexibility than the NPSS.” For example, Turner is proposing that the tax relief available in the NPSS should be at the basic rate only. Higher-rate payers would therefore be better off outside the scheme.
Am I saving enough into my money-purchase scheme?
Probably not. The average contribution is 9% and average earners need to pay in 16% to get two-thirds of their income in retirement.
You should aim to pay in as much as you can afford through AVCs. At present, the maximum is 15% of your earnings, but from A-Day it will be 100% of your salary or £215,000, whichever is lower.
What can I expect from the state pension?
Turner would like to see a more generous state pension in return for linking the retirement age with life expectancy. He would link the state pension to earnings from 2010 or 2011. The basic state pension would also be universal — based on residency rather than contributions, to give women and others with broken careers a better deal.
At present, only 17% of women are entitled to a full basic state pension in their own right, compared with 92% of men, according to the Fawcett Society. This is because it penalises women for taking time out of work and working part-time to care for the family.
Turner also suggests that members of money-purchase and personal pensions should contract back into the state second pension. Many pension companies have already written to their customers to this end.
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Can’t I already work later if I want?
Yes, it is possible to defer your state pension and take a higher one at a later age. Turner would enhance this option and suggests that workers should be able to take part of their pension and defer the rest, as they will be able to do with company schemes from April 2006.
To qualify for a higher weekly pension, you must defer for at least five weeks. Your pension will increase by 1% for every five weeks you do not claim, compared with 1% for every seven weeks before April 6.
To qualify for the lump sum, you must defer for at least 12 consecutive months. Your lump sum will be based on the weekly state pension you would have received plus an interest rate at 2 percentage points above the Bank of England base rate. Your weekly pension will then be paid at the normal rate.
A person deferring a state pension of £105 a week (basic plus state second pension) would get a lump sum of £5,646 if he or she deferred for one year, £11,673 for two years and £32,306 for five years, assuming a rate of 6.75%.
HOT PROPERTY
SIMON FREEGARD, a 35-year-old mortgage broker who lives in north London, is one of the thousands of people who are relying on property rather than traditional pensions for their retirement.
Freegard’s employer, Savills Private Finance, does not contribute to a company pension because staff prefer a bonus that they can invest in property, it says.
Freegard has two buy-to-let properties that he sees as his retirement fund.
‘I’m planning to build up my buy-to-let portfolio over the next few years and I’m confident that it will give me a decent income in retirement, but I would not want to become complacent.’
Under Turner’s proposals, firms such as Savills Private Finance could be forced to contribute to the proposed National Pension Savings Scheme.
LOW EARNER
KEITH PAUL, 31, a gardener from Islington in north London, says he doesn’t earn enough to contribute to a pension.
He said: ‘I’m happy to stick with a relatively low-paid job because I love it. But that means I’m still struggling to pay off my overdraft, let alone pay into a pension.
“I suppose I will have to rely on inheriting my parents’ house in Romford.’
Even if Keith has access to the National Pension Savings Scheme, it would be of little use until he has cleared his debts.
MAXIMUM SAVER
KEVIN FARRIS, 41, is saving the maximum possible into a personal pension because his employer does not contribute to a company scheme.
Kevin, who lives with his son, Christopher, 12, near Ashford in Kent, works for a small aromatherapy firm. ‘I’m not sure that the company or some of my fellow workers could afford to contribute to a pension,’ he said.
He pays 20% of his net earnings into a pension on the recommendation of his financial adviser, Simon Webster of Facts and Figures.
ON TARGET
KATY LITT, 25, is not happy about Lord Turner’s suggestion that she should work until 67, but recognises she is one of the lucky ones because her employer, Norwich Union, provides a generous company scheme.
Katy, a public-affairs consultant who lives in York, said: ‘In an ideal world, I would love to retire at 60. If the state pension age went up to 67, I would face another 42 years in work, which seems daunting. But I accept that people are living longer, so it is inevitable that retirement ages will rise over time.’
Katy contributes 4% of her earnings to her company’s money-purchase scheme, while Norwich Union puts in 12% — a total of 16%.
This is the amount Turner suggests you set aside for a pension of about two-thirds of earnings, so Katy should be on target for a comfortable retirement.
COMFORTABLE
MARY TAYLOR, 59, will collect the full basic state pension next year, which makes her one of a lucky minority. Only one in five women have made sufficient contributions to get the full state pension, and the age at which they qualify will go up to 65 in 2020.
Mary, who lives near Edinburgh, also gets a relatively generous final-salary pension from Scottish Provident, the insurer where she worked as a document-keeper for 23 years.
She says that her company scheme, combined with the state pension, will give her a comfortable retirement.
WE’LL WORK ON
Even though 60-year-old John East has two company pensions and the state pension to come, he still feels that he and his wife, Kathleen, 59, will have to keep working for the foreseeable future.
He said: ‘We have to keep going or we’ll go under.’
East works at a garage in Old Amersham, Buckinghamshire, while his wife develops photos at the Amersham branch of Boots.
This year he started drawing £82 a week pension from Scottish & Newcastle and £64.20 a month from another employer, Luxfer Group.
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AT A GLANCE GUIDE FOR DIFFERENT AGE GROUPS
Recently retired
You are likely to be one of the lucky ones, according to Turner. In his report, Turner said: “On average, current pensioner income is at an historic high relative to earnings.”
Age 50 to 65
You are also in a good position. Six out of ten people in this age group are on target to retire with pensions that are significantly better than “adequate” (defined as 67% of final earnings for an average earner). You should probably start thinking about A-Day, however. Tom McPhail of Hargreaves Lansdown, an adviser, said: “A-Day will offer some fantastic opportunities.”
Age 40
You can expect to retire at 66 if Turner gets his way. And you should save as much as possible. The Turner report says that you need to save 19% of your salary, assuming you start now, if you want to retire with a pension worth about two-thirds of earnings.
Age 30
You can expect to retire at 67 and you should be saving about 11% of your salary to build up a good pension pot.
Age 20
You can expect to retire at 68 and you should be saving 8% of your salary.
FACTS AND FIGURES
- People are living longer. In 1980, the average man aged 65 could expect to live another 14 years, compared with an estimated 19.4 years today and 23.6 years in 2050.
Life expectancy for the typical woman at 65 has gone up from 18 years in 1980 to an estimated 22.1 years today and 25.9 years in 2050.
- A person who saved for 40 years would have a fund 30% higher if charges were as low as 0.3% a year, compared with the usual 1.5%.
THE HISTORY OF PENSIONS
1908: The first state pension was set up by David Lloyd George, the Liberal chancellor and future prime minister. It was means-tested and not paid until 70.
1942: Sir William Beveridge recommended a universal but basic flat-rate state pension that would provide just enough to live on. It was set up in 1946 and paid for by National Insurance contributions.
1975: Labour’s Barbara Castle extended the basic state pension to include an earnings-related component known as the State Earnings Related Pension Scheme, or Serps. The basic state pension was also linked to the growth in people’s earnings.
1980: The Conservatives cut the link between the basic state pension and earnings, indexing it instead to prices.
1986: The Conservatives reduced the benefits of Serps and encouraged individuals to opt out of the state scheme, called contracting out. This explains the explosion of personal pensions in the late 1980s.
1987: Workers were given the right to opt for a personal pension rather than remain in their company’s occupational scheme. However, this led to the first big pensions mis-selling scandal as financial advisers encouraged people to dump generous company schemes for inferior personal pensions.
2002: A government green paper on saving for retirement gave rise to the forthcoming “A-Day” (April 6, 2006), when eight company and personal-pension regimes will be rolled into one.
