July 10, 2012 1:28 pm

Look to Australia for workable pension plans

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Pensions minister Steve Webb is not short of ideas. Over the past year we have seen an avalanche of initiatives from the minister’s office as he battles to win over the nation to the concept of long-term pension saving.

His motivation is clear, as within a few months he will oversee the historic launch of auto-enrolment – where millions of workers will be signed into company pension schemes for the first time.

The success of this experiment – and whether his government needs to consider moving to the politically unpalatable step of compulsion in pension savings – very much depends on numbers not opting out at the first chance.

In essence he needs to convince workers that sacrificing a slice of their salary to invest in risky defined-contribution pensions – in times of significant pressure on household budgets – is worthwhile.

The minister’s latest idea to win over reluctant savers, is to introduce insurance sold alongside pensions.

He has come up with the catchy concept of the “money safe” guarantee which would give savers the comfort of knowing that after a lifetime of saving they would at least get contributions – theirs and their employer’s – and tax relief, back in nominal terms.

A guarantee might soothe the nerves of the reluctant first-time pension saver. But this idea has red flags flying all over it, from cost to potential mis-selling concerns.

Even at the relatively low cost of 0.5 per cent, a guarantee could shave tens of thousands off a pension fund. For example, a saver setting aside £200 a month for 40 years, who achieved growth at 5 per cent per annum, could end up paying £60,000 for a guarantee. That’s £60,000 that won’t be invested in their fund.

Broker Hargreaves Lansdown argues that merely guaranteeing the nominal value of a fund – and not protecting its spending power - would be pointless.

“If you wanted to pay more to protect your spending power – for a guarantee that was inflation linked – then the OECD suggested that this could cost, on average, about a quarter of the pension payout,” says Hargreaves.

“That means for each £100 you contribute, about £25 is effectively being used to provide that guarantee, rather than being invested for your retirement.”

There is a chance that guarantees could prove valuable for some, particularly if they are genuinely low cost.

But certainty could come at a high cost for many, who could end up handing over large chunks of their retirement pot to insurers, some of whom have a poor track record on guaranteed products. Think precipice bonds. Think with-profits. Think Equitable Life.

I have another idea. Instead of asking savers to buy downside protection, why not put pressure on active fund managers to deliver better value for investors?

A recent OECD report suggests there is scope for exploring why British savers have suffered bigger losses from their workplace pensions in the past decade than virtually every other nation in the developed world.

Perhaps we could consider the Australian approach, where for nearly 20 years the government has compelled its citizens to pension save. There is now a push Down Under to oust “dud” superannuation funds which do not deliver decent returns.

Instead, workers would have their retirement savings channelled only into the top funds in a reform pursued by powerful industry funds that want performance benchmarks applied for the first time since the system was set up nearly 20 years ago.

With millions of British workers about to be enrolled into workplace default funds, this might be worth thinking about.

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