Pensions: Work longer, save more

Great change is afoot in the arcane world of pension provision.

The bright side is the potential end of pensioner poverty, but the cost will be high. Planning and preparation will minimise the hardship, says Charles Nall.

The world of pensions has moved on: the Pensions Commission has reported, the Government is considering what to do next, the Pensions Act 2004 and its regulator are in action, and the Pension Protection Fund is collecting its levies. Now is the time for charities to make sure they have moved on too.

Pensions are expensive and people aren't saving enough, according to the commission. Its final report advocates working longer and saving more into a national pension savings scheme - a proposal that should be embraced.

Whatever happens, many people will retire on less than they hoped. The message for employers is clear: prepare for increasing pension costs.

The commission's report focuses on lower and median earners (about £22,000 a year - reasonably well paid in charity terms). At the median salary, a decent basic state pension needs to be topped up by a further 16 per cent of pay to provide a modest comfortable retirement. Taking into account increases in longevity, the cost of a good basic pension hasn't changed since the 1970s.

The commission recommends topping up by 8 per cent, which lifts individuals out of poverty but doesn't give a comfortable retirement. Responsible employers might wish to help staff achieve the 16 per cent level, although the raw economics of cost are a major deterrent.

One way of ensuring that employees save more would be to make contributions compulsory. The commission eschews this idea, but embraces automatic enrolment into the basic 8 per cent scheme: for every £8 contributed, an employee would contribute £4, the employer £3 and government £1. Where it is used, 85-90 per cent of employees do not opt out of automatic enrolment.

The final proposals will take months to emerge, but the scheme is likely to come into effect around 2010. When it does, employers face the prospect of finding 2.7 per cent of each salary. We should expect pressure to move to the 16 per cent level from employees and their representatives. After all, the result is simply sensible pension provision.

Just as FRS17 has shown the true costs employers face with final-salary schemes, so the Pensions Commission is highlighting the true cost to employers and value to employees of defined-contribution pension schemes. Pensions are deferred salary, so employers and employees should expect to negotiate pensions as part of total remuneration. Rather than facing a shock in 2010, charities should press for the commission's proposals to be phased in.

Practical steps

Prudent charities and concerned employers might wish to start the process before 2010, perhaps using a notional scheme to create the financial discipline that will be needed.

All staff without pension provision could be shadow-enrolled, with one-to-one matching contributions starting at 1 per cent of salary and rising by one percentage point a year. Each year these amounts would be increased by further 1 per cent steps, absorbing a third of the employee's typical annual increase of about 3 per cent, matched by the employer. This would reach the commission's level by 2010. This is expensive, but employers do not have to pay National Insurance contributions, so it is cheaper than paying more. And a charity might cap salaries eligible for matching contributions at the top of the basic rate income tax band.

The difficulty comes with existing pension provision and how this interacts with equal pay legislation. The commission's basic proposals offer lower levels of per capita cost but are more expensive because of the higher take-up rate automatic enrolment brings. The real double whammy will be when employers still paying off their final-salary scheme deficits start paying into the national pension savings scheme. Start planning now.

Defined-benefit schemes

Unless your charity has a fairy godmother, it is likely to have closed any such schemes to new members, ensured the retirement age is 65 or above and contracted back in. If the scheme has been closed for a while, high staff turnover rates will sharply reduce membership. However, charities won't want to reach the point where there are no active members because this might lead to trustees closing out the scheme, leading to massive liabilities.

If you avoid eroding the accruing benefits, you might slow the rate of turnover. You will have to be very firm with your pensions trustees over their investment policy to avoid or at least defer any panicked rush into bonds. Indexed bonds have a real return of less than 1 per cent and bonds look over-priced, whereas equities look good value, with a real return of about 5 per cent.

You will have to have an employer's (not a scheme's) valuation carried out using the latest longevity assumptions, assumed equity returns pre-retirement and AA bond returns post-retirement. You may have blanched at the cost when you realised that the pensions regulator's desire to see deficits eliminated over ten years included your charity. Undeterred, you will have set about increasing contribution levels and negotiating these into contracts. You will also need to remember the Pension Protection Fund levy, expecting that it could quintuple over the next ten years.

With these changes, the level of pension saving over the next ten years will skew the economy away from consumption, so expect lower economic growth, less trading profitability, higher tax rates and lower fundraising returns. Caution and foresight are the watchwords, but the upside is the possible eradication of pensioner poverty.

Charles Nall is corporate services director at the Children's Society.

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