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FT editor Roula Khalaf picks her favorite stories in this week’s newsletter.
The writer is a contributing editor to the FT
The reform of the UK pension system has had a long history of beginnings. Since 1998, about 17 people have held the position of Minister for Pensions. But finally the head of steam is building. With the UK having the third largest stock of pension assets in the world, this is much needed.
While pension assets are substantial, the landscape is incredibly fragmented. The UK has over eight thousand pension schemes – and that ignores the tens of thousands of ‘micro’ schemes. Lack of scale makes infrastructure and venture capital investments prohibitively expensive for most. Consolidating the system’s assets to address this was central to the so-called “Mansion House reforms” brought in by former chancellor Jeremy Hunt last year. The Pensions Bill, which has just been introduced in the King’s Speech, looks very much like the new Labor government, which continues Hunt’s work.
Firstly, so-called ‘value for money’ tests will now be applied to defined contribution schemes. The idea is that funds that compare poorly in terms of costs and investment returns will be forced to liquidate and transfer their assets to those that do better.
The second is a plan to extend the obligation of pension funds to provide care until retirement. New auto-enrolled pension contributions currently flow overwhelmingly into master trusts – pooled funds that have professional independent trustees with statutory administration. Currently, the default pathways lead members to save during their employment. But in retirement, people may find themselves transferring their retirement assets into a low-value retail product. By extending carers into retirement, it is assumed that pensioners will achieve better outcomes and that the wider benefits of consolidated pension funds will last longer.
Third, defined benefit schemes will now be better able to consolidate through so-called commercial super funds. This overdue legislation will complete a process that began more than eight years ago.
Despite these steps, the new government’s approach still appears evolutionary rather than revolutionary. As Sir Steve Webb, partner at LCP and former pensions minister, says, “this is a quick bill – the deeper thoughts come later”. Labor has committed to a holistic review of pensions in its manifesto. So what deeper thoughts might it involve? Various radical options pop up.
While automatic enrollment has been a major pension success over the past decade, contribution rates of 8 percent of salary are still low. Minimum contributions in Australia and Sweden are around 12 and 18 percent of salary, respectively, and New Financial — a capital markets think tank — estimates that 20 percent or more is typical for Canadian and Dutch workers.
Further, Chancellor Rachel Reeves has said she has “no plans” to change pension tax relief. HMRC estimates that the reliefs – currently graduated to match marginal rates of income tax – cost more than £48bn net each year. About three-quarters of those go to higher-rate taxpayers, according to a 2020 report by the Pension Policy Institute. A move to a flat rate of tax relief could be revenue-neutral, substantially boosting incentives for lower-income workers to save for retirement and increasing the share of relief they take. However, according to the Association of Pensions and Savings Banks, such a change would require a multi-year review of pay systems, so it would require a long preparation time.
Thirdly, the local authority pension scheme has a substantial asset base of over £425 billion. But because it is fragmented among 86 administrations, it is denied the benefits that its scale should bring. Moving assets into a single fund would create a globally significant pool and generate huge savings. Of course, stripping local authorities of their asset allocation and oversight powers could prove politically difficult, but it is worth it.
Finally, the UK should look abroad for inspiration. Investing public sector pension contributions in productive assets could save taxpayers money, deepen capital markets and boost national savings. The Canadian and Swedish governments have shown how to make this transition. We should follow them.
Some readers are likely to pay close attention to the changes to the tax-free inheritance of defined contribution pension funds. For years, the Institute for Fiscal Studies has called the current treatment “inexcusably generous.” In today’s system, it may make sense for those with large assets to transfer to fund their retirement by remortgaging rather than drawing on their pension. This is crazy and Labor has yet to deal with it. This retirement account may ruffle a few feathers, but the next one could be even more interesting.