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A Consultation Document issued by the Department of Social Security

Introduction

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to respond to the consultation document on the Stakeholder Pension issued by the Department of Social Security. Our principal conclusions are set out in the following paragraphs.

Executive Summary

In the light of the continuing relative decline of the value of the state pension, the Government is right to explore how best to extend the spread of secondary pension provision, and to focus its attention on devising plans which are likely to prove attractive to those groups which currently make no or little independent pension provision.

The basic aims behind the stakeholder pension project, namely to lay the foundations for schemes which are simple to understand, secure, flexible and cost-effective, are sound. The achievement of these aims is, however, likely to prove difficult in practice and some of them may have to be diluted in the interests of minimising scheme costs.

In order to implement successfully the stakeholder policy project, it will be essential for the Government to adopt a co-ordinated policy towards long-term saving. This co-ordinated approach will involve, firstly, accepting the desirability of encouraging people to invest for their own retirement, and, secondly, pursuing fiscal and other policies designed to offer material enhancement to savings and benefits.

The introduction of the stakeholder model could be used to rectify a serious weakness in the current framework of money purchase schemes. The unpredictability and volatility of annuity rates mean that the value of any individual's pension in retirement is wholly dependent on the annuity rates which apply at the time of purchase. This is fundamentally unfair. We propose a new approach whereby the capital value of pension rights would be retained by the retiring individual so that the income generated would, effectively, represent pension income. This approach would overcome the inequality between the sexes where annuity rates for women are lower than for men.

While it is highly desirable for encouragement to be given to those currently without any secondary pension to consider investing in a stakeholder pension, the Government must be careful to avoid giving employers any additional cause to withdraw from running good occupational schemes.

Our full response to the consultation document is set out below.

1. In the long-term, the basic state pension, which the Government is committed to retaining as the cornerstone of pension provision in the UK, can only, realistically, be expected to provide a very basic level of retirement income for pensioners. The prediction, quoted in last year's report by the Director General of the Office of Fair Trading (OFT), that by the year 2030 the basic pension will be worth only 9% of average earnings, bears this out. In view of this, and in the absence of any return to the indexing of the basic pension to average earnings, it is imperative that the Government acts with urgency to extend the spread of secondary pension provision.

2. The UK's occupational pension system, relative to the framework of pension provision in other EU countries, is healthy insofar as it is a tried and tested basis of secondary pension provision for those who are covered by it. We support the Government's conclusion, in developing its stakeholder pension proposals, that the focus of its new initiative needs to be on reaching those groups in society which have, traditionally, made no or little independent provision for their retirement. Accordingly, the Government's efforts to devise a scheme which is able to meet the needs of the self-employed and those low-paid employees who do not currently have the opportunity to join occupational schemes is to be welcomed.

3. The aims of the stakeholder pension initiative, as set out in paragraph 9 of the consultation document, are laudable in themselves, and appear to have been drafted with the intention of addressing some of the justifiable criticisms of traditional schemes made last year in the OFT report. We would not dispute that, ideally, a new type of pension scheme should be constructed in such a way as to make it affordable and simple to understand; secure in terms of the integrity of the scheme assets and of the benefits payable in retirement; flexible in terms of portability and ability to accommodate changes in contribution patterns; and cost-effective for pensioners.

4. We suspect, however, given the financial circumstances of the target groups, the achievement of these aims may not be a realistic proposition. As an illustration, many of the measures introduced by the Pensions Act 1995 have had the (welcome) objective of enhancing the security of scheme assets, but the consequence of these improvements has been a significant increase in the obligations and liabilities of those who run schemes, and has reportedly led to some reflection on the part of employers as to whether they wish to continue running occupational schemes at all. The minimisation of costs will be particularly important in the case of stakeholder pensions, and scheme objectives should not be so ambitious as to prevent costs being kept to an appropriate level given the nature of the scheme.

5. It must be recognised at the outset that a major reason for the current lack of independent provision by the self-employed and the low-paid is the shortage of funds available to them to allocate for this purpose. For many in these constituencies, this position will not change.

6. Unless effective action is taken at Government level to address this factor, many in the targeted group will not be encouraged to invest in a stakeholder pension and, even if they are compelled to do so, the level of the pension to which they will be entitled risks not being sufficient to provide them with any material supplement to the basic state pension.

7. We suggest, therefore, that the core of the Government's approach to stakeholder pensions needs to be how it can help to enhance the value of stakeholder pension funds and their members' benefits. This will necessitate a co-ordination of policy as between the relevant arms of Government, based on an acceptance of the principle that helping workers now to fund their retirement will prove beneficial both to the workers themselves and to the State. In certain respects, it has to be said that, at present, there is a lack of such co-ordination. The recognition of the importance of encouraging secondary pensions, as evidenced by the stakeholder initiative, is difficult to reconcile with factors such as the withdrawal of tax credits to pension funds, which will continue to impact particularly adversely on the self-employed; with the proposed restriction on incentives for long-term savings in the new Individual Savings Account; and with the monetary policy of the Government, which is a contributory factor in the dramatic fall in annuity rates. In urging this co-ordinated policy approach, we would point out that the operation of the social security system needs also to be taken into account since, at present, those who are entitled to a very small secondary pension can, in fact, end up worse off than those with no secondary pension at all.

8. First and foremost, there needs to be clarification about how tax law would apply to contributions, funds and benefits. In fact, given that tax considerations are acknowledged to be a major element in pension planning, it is surprising that no mention of this aspect is made in the consultation document. We believe that the provision of tax incentives will be an essential factor in the successful marketing and operation of stakeholder pensions. Most importantly, the principle of tax neutrality must be accepted, so that, if contributions to a scheme are not to attract tax reliefs, the resulting benefits should not be taxable.

9. Secondly, we believe strongly that the stakeholder pension rules should not require investors to purchase an annuity policy following their retirement. At present, dependence on prevailing annuity rates has the potential to cause serious inconvenience to pensioners, a problem which the recent extension of the purchase deadline has only partly resolved. We see it as being acutely unfair that an individual who retires in year 1 can benefit from a materially higher annuity rate (which is fixed for the duration of the policy) than someone who retires in years 2 or 3. The recent steep decline in annuity rates brings this unfairness home to all those who are retiring at the moment. We do not believe that the security of an individual's retirement fund should be so dependent on the volatility and unpredictability of annuity rates. Also, the value of the annuity will be dependant upon life expectancy, so that those living longer will gain while others with low life expectancy will lose. This can be termed a 'lottery on life'. The modest value which can be expected to accrue in many stakeholder funds makes it, we suggest, all the more desirable that the level of their pension should not be subjected to such uncertainty.

10. Instead of the annuity-based approach, we propose a new approach, whereby the capital value of a person's pension rights would be retained by the retiring individual so that the income generated would, effectively, represent pension income. For those with money purchase plans, the amount which they would be able to retain would be represented by the assets of a pension fund. This new approach would not interfere with existing commutation rights, which allow 25% or more of the fund to be converted. It would also overcome the inequality between the sexes where annuity rates for women are lower than those for men. The member would benefit from such an arrangement since he would not be prejudiced by unfavourable annuity rates; neither would his capital fund be lost on his early death

11. In the case of women members, the credits which are currently paid to those taking time off to raise children could be paid directly into their funds. We also envisage that contributions into a fund would not be restricted to a proportion of income, so that members with low or erratic earnings would be free to pay in any windfall funds which they might receive.

12. As well as being logical from an investment perspective, avoiding the unfairness of the annuity rules, we suggest that this approach would be attractive to potential investors in stakeholder pensions. It could also be a solution to the problem of differential annuity rates for men and women, whereby women currently receive significantly less pension income than men. The harmonisation of annuity rates through the lowering of rates for men, as has recently been suggested, would not be a satisfactory response to the problem. Our suggestion that the purchase of an annuity should be replaced altogether would, we believe, be a more radical but better solution.

13. A novel application for our suggested capital fund relates to payment for health care. Studies have suggested that, although people may now be living longer, they are not necessarily living healthier lives, and more and more of us can expect to have to resort to specialist health care in our old age. We propose for consideration that a member with a capital pension fund should be entitled to withdraw part of his fund to pay for any necessary long-term health care. As well as providing a degree of assurance to the member that he will be able to meet such costs should the need arise, this means of funding essential costs could go some way to easing the potential burden on the State.

14. We consider that the rules governing stakeholder pensions will need to address the contentious issue of the status of a member's rights in the event of his bankruptcy. ACCA believes that the present distinction between the security of rights in bankruptcy as between members of occupational and personal schemes is unjustified, and discriminates against the latter. If a reasonable level of protection were not extended to stakeholder pensions, it would seriously affect their marketability. The fact that stakeholder pensions are to be offered to employees and the self-employed alike implies that some resolution of this problem is inevitable.

Specific Points

We offer the following comments on specific matters raised in the consultation document.

Payment of contributions

(i) A key factor in the marketability of stakeholder pensions will be the ease of paying in contributions, both on the part of workers and employers. For this reason, we see merit in the consultation document's suggestion for the creation of a clearing house. This type of system would be of considerable help to employees when changing employer. With respect to the reference in paragraph 29 of the document to the desirability of identifying new 'providers' of stakeholder schemes, we do not see that this is the key issue. Rather, the important thing is to ensure the quality of schemes which are set up.

Contracting-Out

(ii) We agree that contracting out of SERPS has the potential to benefit members of stakeholder pension schemes. The implications of this, however, need to be carefully thought through, since the complexity associated with the administration of contracting out arrangements could seriously affect the objective of keeping the new schemes simple.

Past rights

(iii) A system for the transfer-in of protected rights or GMP could be investigated in order to shorten the transitional period. In the interests of simplicity, any transfer made must be on the basis of a simple money purchase value payment. Strict guidelines must be established for such transfers in order to avoid a repeat of the problems caused by transfer advice over the past decade.

The scale of administration required for the provision of GMPs and protected rights inevitably increases scheme costs. A major cause of the workload is the link between individual earnings and the level of benefit provided or contributions paid.

One of the central aims of the stakeholder pension project is to devise a type of scheme which is simple and cheap to operate. Accordingly, any measure which could contribute to the achievement of these goals need to be explored. For example, by breaking the link between salary and benefits/contributions, administration would be eased and costs restrained. A more standardised contribution could be paid in place of the current protected rights payments. Also, contributions could be age-related, rather than salary-related.

Payments by the self-employed

(iv) We do not see that it would be practicable to provide for the engagers of the self-employed to make deductions from payments made to them and to transfer those deductions to the member's scheme.

Other financial services products

(v) We agree that the stakeholder pension model offers interesting possibilities for the offer of other financial services products, in particular group life assurance. If our suggestion of adopting a capital fund approach were accepted, the associated premiums could be paid put of that fund.

Investment approaches

(vi) With respect to different approaches to the investment of fund assets, we do not accept that there should be recognition of any 'norm', as suggested in question 29 in the technical annex. While the particular approach referred to in that question might be favoured by many, others might prefer a different approach, and there should be no standardisation in this regard.

Information to members

(vii) We agree that regulations should provide for regular information on the operation of a scheme to be provided to its members. The information should be provided in the form of an annual statement of account. The fundamental objective of the statement should be to reassure members that the scheme is operating effective controls to ensure that contributions are in fact being paid into it.

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