The Pension Schemes Bill. Even the title is dry. And inside there await 102 clauses and 104 pages of pensions law minutiae. Most of the detail will only be of interest to pension industry specialists. But the principles and outcomes baked into this bill matter for all our retirements.
So what does the legislation mean for low and middle earners? There are four changes in the bill that could make a real difference to low-income Britain – and some tweaks that could maximise their impact.
(This paper only looks at Defined Contribution (DC) pensions but there are also reforms affecting private sector Defined Benefit (DB) pensions and the local government pension scheme).
So what does the legislation mean for low and middle earners? There are four changes in the bill that could make a real difference to low-income Britain – and some tweaks that could maximise their impact.
(This paper only looks at Defined Contribution (DC) pensions but there are also reforms affecting private sector Defined Benefit (DB) pensions and the local government pension scheme).
1. Retirement incomes
Today, most people reaching retirement with a DC pot do not turn it into an income: a majority convert their pension into cash, especially if they only have modest amounts. That may not matter too much, if you also have a DB pension. But those who are largely dependent on DC schemes will likely need a steady income in retirement on top of their state pension.
This problem was created by George Osborne in 2014 when he gave people the flexibility to use their pensions as they pleased. Recently ministers from both main parties have recognised that a regular income is a requirement for most retirees and that they need more help to secure one. Two recent reports (on problems and solutions) explored these issues as part of the Pensions Review, which the IFS is conducting in partnership with the Financial Fairness Trust.
The bill presents the government’s answer. It requires pension providers to offer their members a ‘pension benefit solution’ which in most cases must include a retirement income (or they can transfer members to another provider who will do this instead). Schemes will be required to default members into one of these solutions when they reach their pension age, if they have not opted for an alternative.
Pension schemes will be allowed (and may be required) to seek information about members’ circumstances before recommending a default solution. This is important because pension providers typically do not know about people’s other pensions or savings, whether they rent or own their home, or if they live with someone else – all things that could impact the recommendation they make. The bill does not say what happens if pension scheme members do not provide the information requested and this question should be examined during parliamentary scrutiny. Members already need to provide their bank details to access their pension so perhaps a broader set of minimum information should be required?
I have two other anxieties about the current drafting, and both relate to life expectancy. First, should the new arrangements mandate providers to screen out those with very low life expectancies and offer something different? People with long-term health conditions with heightened risk of dying in their 60s should probably be offered cash or an impaired-life annuity.
Second, will these arrangements provide an income for life for people fortunate enough to live for a very long time? The bill does not say that the required ‘regular income’ must be a ‘regular income for life’. Providers could just make payments from a drawdown investment that might run out before the member dies. Pension schemes are busy creating hybrid products that will include guaranteed incomes for the later years of retirement. But the bill only gives ministers the power not the duty to say that default solutions must contain an income for life. It would make sense for this to be stipulated in the bill itself.
Today, most people reaching retirement with a DC pot do not turn it into an income: a majority convert their pension into cash, especially if they only have modest amounts. That may not matter too much, if you also have a DB pension. But those who are largely dependent on DC schemes will likely need a steady income in retirement on top of their state pension.
This problem was created by George Osborne in 2014 when he gave people the flexibility to use their pensions as they pleased. Recently ministers from both main parties have recognised that a regular income is a requirement for most retirees and that they need more help to secure one. Two recent reports (on problems and solutions) explored these issues as part of the Pensions Review, which the IFS is conducting in partnership with the Financial Fairness Trust.
The bill presents the government’s answer. It requires pension providers to offer their members a ‘pension benefit solution’ which in most cases must include a retirement income (or they can transfer members to another provider who will do this instead). Schemes will be required to default members into one of these solutions when they reach their pension age, if they have not opted for an alternative.
Pension schemes will be allowed (and may be required) to seek information about members’ circumstances before recommending a default solution. This is important because pension providers typically do not know about people’s other pensions or savings, whether they rent or own their home, or if they live with someone else – all things that could impact the recommendation they make. The bill does not say what happens if pension scheme members do not provide the information requested and this question should be examined during parliamentary scrutiny. Members already need to provide their bank details to access their pension so perhaps a broader set of minimum information should be required?
I have two other anxieties about the current drafting, and both relate to life expectancy. First, should the new arrangements mandate providers to screen out those with very low life expectancies and offer something different? People with long-term health conditions with heightened risk of dying in their 60s should probably be offered cash or an impaired-life annuity.
Second, will these arrangements provide an income for life for people fortunate enough to live for a very long time? The bill does not say that the required ‘regular income’ must be a ‘regular income for life’. Providers could just make payments from a drawdown investment that might run out before the member dies. Pension schemes are busy creating hybrid products that will include guaranteed incomes for the later years of retirement. But the bill only gives ministers the power not the duty to say that default solutions must contain an income for life. It would make sense for this to be stipulated in the bill itself.
2. Consolidating small pots
The bill introduces a new requirement for pension providers to consolidate small dormant DC pensions. Another IFS report for the Pensions Review examined this issue and found there are 12 million pensions worth less than £1,000 with no current contributions being made. Most of these will belong to low and middle earners.
Small pots are a problem for two reasons. First, they are expensive to administer. They increase costs for providers and therefore fees for savers, and this hits all scheme members not just those with small pots. This is the main reason why the pensions industry wants to see pots of up to £1,000 pooled into ‘consolidator’ schemes unless members object. This is the solution envisaged by the bill.
The second reason is that if people have lots of pensions scattered across many providers, they are more likely to lose track of them and less likely to make good use of them at retirement. Whether it is a saver making decisions for themself or a provider recommending a default solution, the retirement outcome will be better if there is visibility of people’s total pension assets.
Pension dashboards will soon enable people to see all their pensions in one place if they know to ask. But the IFS, the Financial Fairness Trust and many within the industry believe that low-to-middle income savers should ideally reach retirement with one or just a handful of DC pension pots. The bill could allow this to happen in the future, because it gives ministers the power to broaden the definition of a ‘small’ pot beyond the initial maximum of £1,000.
I would suggest a small revision to this power. The bill should give ministers permission to set two or more upper limits on the size of funds that can be automatically consolidated, which could be applied in different circumstances. Then ministers could require that pots of higher value are consolidated when members are close to retirement. This is the stage when people would really benefit from having their pension assets combined.
The bill introduces a new requirement for pension providers to consolidate small dormant DC pensions. Another IFS report for the Pensions Review examined this issue and found there are 12 million pensions worth less than £1,000 with no current contributions being made. Most of these will belong to low and middle earners.
Small pots are a problem for two reasons. First, they are expensive to administer. They increase costs for providers and therefore fees for savers, and this hits all scheme members not just those with small pots. This is the main reason why the pensions industry wants to see pots of up to £1,000 pooled into ‘consolidator’ schemes unless members object. This is the solution envisaged by the bill.
The second reason is that if people have lots of pensions scattered across many providers, they are more likely to lose track of them and less likely to make good use of them at retirement. Whether it is a saver making decisions for themself or a provider recommending a default solution, the retirement outcome will be better if there is visibility of people’s total pension assets.
Pension dashboards will soon enable people to see all their pensions in one place if they know to ask. But the IFS, the Financial Fairness Trust and many within the industry believe that low-to-middle income savers should ideally reach retirement with one or just a handful of DC pension pots. The bill could allow this to happen in the future, because it gives ministers the power to broaden the definition of a ‘small’ pot beyond the initial maximum of £1,000.
I would suggest a small revision to this power. The bill should give ministers permission to set two or more upper limits on the size of funds that can be automatically consolidated, which could be applied in different circumstances. Then ministers could require that pots of higher value are consolidated when members are close to retirement. This is the stage when people would really benefit from having their pension assets combined.
3. Improving value for money
Most low and middle earners who join a pension today are auto-enrolled into large multi-employer ‘master trusts’ run by providers such as Nest, the People’s Pension or large insurance companies. These schemes have low fees and the contributions go into default funds that have significant scale. Providers are chosen by employers and their advisers, not individual employees, and businesses usually select on the basis of cost and convenience.
But there is significant variability in the returns these funds generate and therefore in the likely incomes people will receive in retirement. To address this challenge the bill will introduce a new framework to measure the value for money that DC pensions offer, taking account of factors including investment performance and customer service. It is hoped that a transparent scorecard will lead to employers making pension choices that maximise outcomes for their employees in the long term. The government considered introducing further obligations on employers and their advisers but is not progressing this for now.
Pension providers will also be expected to use the information on value for money to improve their standards or transfer members into better arrangements. This could particularly benefit people who have old DC pensions which may have higher charges and lack the benefits of scale. The bill will also allow all schemes to automatically transfer members into pensions that better meet their needs, without requiring consent.
We know that low earners rarely make active choices about their pensions, like transferring to a better scheme, so these new value for money requirements are an essential consumer protection.
Most low and middle earners who join a pension today are auto-enrolled into large multi-employer ‘master trusts’ run by providers such as Nest, the People’s Pension or large insurance companies. These schemes have low fees and the contributions go into default funds that have significant scale. Providers are chosen by employers and their advisers, not individual employees, and businesses usually select on the basis of cost and convenience.
But there is significant variability in the returns these funds generate and therefore in the likely incomes people will receive in retirement. To address this challenge the bill will introduce a new framework to measure the value for money that DC pensions offer, taking account of factors including investment performance and customer service. It is hoped that a transparent scorecard will lead to employers making pension choices that maximise outcomes for their employees in the long term. The government considered introducing further obligations on employers and their advisers but is not progressing this for now.
Pension providers will also be expected to use the information on value for money to improve their standards or transfer members into better arrangements. This could particularly benefit people who have old DC pensions which may have higher charges and lack the benefits of scale. The bill will also allow all schemes to automatically transfer members into pensions that better meet their needs, without requiring consent.
We know that low earners rarely make active choices about their pensions, like transferring to a better scheme, so these new value for money requirements are an essential consumer protection.
4. Scale and asset allocation
The bill will require that providers’ main default funds have a minimum scale of £25 billion and commensurate investment capabilities. This provision is in line with existing trends as DC pension schemes are already growing quickly in size and sophistication. The UK is likely to end up with an Australian-style system, where most workers save with a small group of very large pension funds.
More controversially, the bill also includes powers for ministers to mandate DC schemes to allocate a proportion of their funds to private markets. This is a legal backstop to the voluntary Mansion House accord on productive investment to which most of the main pension providers signed-up in May. The government hopes this will lead to investment in infrastructure, property and scale-up businesses across all parts of the UK. The government has said that the power to mandate asset allocation will only be used if progress has not been made and it will lapse in 2035.
Low and middle earners should benefit from greater scale as it will lead to lower costs per member. The gains to be had from increased investment in private markets are less clear cut. Allocating assets to unlisted businesses and infrastructure may benefit the UK economy and therefore boost living standards. But there is no certainty that it will lead to better net returns for savers, compared to low-cost investments in global equities.
Consumer champions, trade unions and pension scheme trustees need to watch these developments closely to ensure that the interests of low and middle earning members are not sacrificed. The government argues that more diverse investment strategies should lead to (slightly) higher returns. Time will tell. Outcomes for low-income savers must not be allowed to end up worse than they would have been without the government’s involvement.
The Pension Schemes Bill has significant implications for low and middle earners. But it is only the start. The government will also shortly launch a second stage of the pensions review, focused on adequacy and pension inequalities. It is the next piece in the jigsaw that needs to be completed to build financial security in later life for all.
The bill will require that providers’ main default funds have a minimum scale of £25 billion and commensurate investment capabilities. This provision is in line with existing trends as DC pension schemes are already growing quickly in size and sophistication. The UK is likely to end up with an Australian-style system, where most workers save with a small group of very large pension funds.
More controversially, the bill also includes powers for ministers to mandate DC schemes to allocate a proportion of their funds to private markets. This is a legal backstop to the voluntary Mansion House accord on productive investment to which most of the main pension providers signed-up in May. The government hopes this will lead to investment in infrastructure, property and scale-up businesses across all parts of the UK. The government has said that the power to mandate asset allocation will only be used if progress has not been made and it will lapse in 2035.
Low and middle earners should benefit from greater scale as it will lead to lower costs per member. The gains to be had from increased investment in private markets are less clear cut. Allocating assets to unlisted businesses and infrastructure may benefit the UK economy and therefore boost living standards. But there is no certainty that it will lead to better net returns for savers, compared to low-cost investments in global equities.
Consumer champions, trade unions and pension scheme trustees need to watch these developments closely to ensure that the interests of low and middle earning members are not sacrificed. The government argues that more diverse investment strategies should lead to (slightly) higher returns. Time will tell. Outcomes for low-income savers must not be allowed to end up worse than they would have been without the government’s involvement.
The Pension Schemes Bill has significant implications for low and middle earners. But it is only the start. The government will also shortly launch a second stage of the pensions review, focused on adequacy and pension inequalities. It is the next piece in the jigsaw that needs to be completed to build financial security in later life for all.