How’s this for a scary statistic? According to the ONS, there are currently 21 million workers in the UK labour force (72% of the total) who are not saving for a pension.
With many employers in the private sector having withdrawn the offer of a pension scheme for their employees, and private pensions being characterised all too often by high fees and meagre returns, it’s not surprising that so many British workers have effectively turned their backs on putting money away for the future.
Yet this situation creates a huge time bomb for the government. If the status quo were to persist, millions of people could potentially end up leaving the workforce with little more than their state pension to rely on, worsening pensioner poverty and piling additional pressure onto the welfare system and other government services.
Fortunately, the politicians have decided to do something about it. Their answer to this problem is the National Employment Savings Trust, or NEST, a new scheme which went into operation earlier this month. Here’s a brief guide:
How does NEST work?
First announced in 2010, the most important element of NEST is that it requires all companies which employ more than a certain number of people to offer their workers an occupational pension.
This represents a major change. Previously, pensions have always been offered entirely at the employers’ discretion, with the result that many firms have stopped providing them over the last two decades because of increased costs from changes to the tax regime and higher life expectancy.
This obligation is being phased-in in stages, starting with the biggest employers in October 2012, and finishing with organisations which employ fewer than 30 people in 2017. All the exact specifications regarding the details are available from the NEST website.
Once this requirement applies to them, firms are able to set up their own pension schemes to fulfil their obligations, or they can join the new NEST scheme. This is the other big part of NEST – a group of brand-new, government-managed pension funds which will invest the workers’ contributions for them on their behalf.
NEST will provide people with a defined-contribution (also known as money-purchase) pension, whereby workers pay a certain percentage of their salary into one of these funds each year, which then attempts to make their money “grow” for them. When they want to retire, the worker uses the money to purchase an annuity from an insurance company – a product which will give them a certain level of fixed income every year for the rest of their life.
The advantage of the NEST funds is that they will be very low-cost compared to the management fees and commission charges which often put people off traditional private pension funds. Participating workers will only have to pay a fee of 0.3% of their salary a year to cover the running costs of the scheme, alongside an initial fee of 1.8% to cover the cost of setting up the scheme, which the government says it plans to abolish after a few years. This compares very favourably to the charges levied by ordinary pension funds, which can consume up to half of the fund’s total value during the years when money is being set aside.
The details are likely to change in the future, but at the moment the minimum contribution by workers is 1% of salary, scheduled to rise to 5% by October 2018. Employers are also required to pay in a minimum contribution as well, which will rise from 1% to 3% over this period.
Despite the government obligation, freedom and flexibility remain important. The whole NEST scheme is voluntary: employers have to offer a pension scheme for their workers, who will be auto-enrolled, but employees can withdraw from it if they would prefer to make their own arrangements. Likewise, the contribution levels outlined above are the minimum level which is required – people can pay more in if they are more concerned about setting money aside for the future.
Different funds are being set up within NEST, so that people will be able to choose the investment strategy that suits them. The basic strategy outlined in the guides provided by NEST is for most people to start off building up their fund in a low-risk investment portfolio which will allow it to accumulate for a number of years, before giving people the option of moving to a higher-risk alternative fund during the middle of their working lives if they want to make their money grow more quickly. As people near retirement age, they will be advised to switch back to a low-risk fund, so that they can plan for the future with a good idea of how much money will be available to them in the years ahead.
NEST has been designed to address two significant problems with private pension saving. Firstly, a NEST fund is portable, so people can move between different jobs and still continue building up the same pension fund – unlike at present, where many people end up with several small, low-value funds from each of the jobs they’ve held.
NEST is also meant to be impregnable; once you’ve put your money in, you can’t get it out again until you are at least 55. This will prevent people from being tempted to “raid” the cash they’ve put aside for spending on short-term costs, making sure it will all go towards a more financially secure retirement.
Are there any weaknesses?
It’s important to remember that NEST hasn’t even come into operation yet for the vast majority of workers, so it could be several years before any problems with how the scheme operates become apparent.
The biggest obstacle to its success is likely to be if too many people chose to opt out. Disengagement with pensions among the general public appears to have reached such a level that many people are likely to simply not understand how the scheme workers, or think that any pension scheme can represent good value. This has not been helped by a certain amount of negative media coverage, which has emphasised the amounts of money people will have to forego in the present through making contributions, rather than the benefits they can expect in the future.
NEST has attempted to address this through a national publicity campaign, which includes literature specially designed using focus groups to assess what kind of language employees are most receptive to; but as it is, peoples’ perception that pensions are a bad idea may be tough to overcome.
The major structural weakness which has so far been pointed out is that NEST may not allow people to save enough money to afford a decent retirement. The minimum contribution levels are unlikely to allow people to purchase a significant annuity at current prices (although these may be different in 40–50 years time, when the first people who’ve had a NEST account throughout their working life start retiring).
Importantly, people are not allowed to import existing pension funds into the NEST scheme, meaning many older workers will only accrue fairly meagre savings in NEST before they reach retirement. Individual contributions have also been capped each year, allegedly because of lobbying by the pensions industry, which fears it could lose a lot of business to NEST if people start abandoning traditional private pension funds in favour of it.
Reasons for optimism
When assessing the merits of government policy, it’s often useful to differentiate between initiatives which look like a bad idea from the start, and good ideas which might have some problems with how they are executed.
It can’t be emphasised enough that, from the point of view of Britain’s future, NEST is a very good idea. If all goes well, it should solve much of our present pensions crisis, and enable millions of private-sector workers to look towards old age without a crippling sense of worry about their finances.
Inevitably with such a major scheme, affecting millions of people, there will probably be significant teething problems. Yet NEST deserves our perseverance. After all, it’s an example of a government policy which takes the future very seriously into account – and if there’s one thing Britain needs, it’s more long-term thinking.