Pensions reform 2015: time to rewrite the rule book?

In a new consultation, the government has effectively asked: is it time to re-write the rule book on pensions?

For many years people have implicitly agreed to save while they work so that they don't fall back on the state in their old age. In exchange for using those savings for retirement purposes, the state provides savers with tax breaks on an exempt-exempt-taxed (EET) basis, in which contributions and investment returns are tax exempt while retirement income, with the exception of a 25% lump sum entitlement, is taxed.

But even with the introduction of the 'freedom and choice' regime, giving people more control over how they access those savings in retirement, the issues first identified in 2004 remain. People are living longer and will continue to do so, and millions of those people are not saving enough to provide for their retirement. The solution arrived at by the Pensions Commission was auto-enrolment, which is now in place for all but the smaller end of the employer market. The government's Green Paper, Strengthening the Incentive to Save, gives us the opportunity to think again and to come up with another solution.

Reinventing automatic enrolment

Far from being seen as a mistake in need of correction, auto-enrolment has generally been seen as a success - albeit with a few inevitable wrinkles.

Employers have, overwhelmingly, chosen to automatically enrol their workers into defined contribution (DC) schemes. In broad terms, the savings outcome from such schemes is determined by:

• the amount of contributions paid into the scheme;
• the investment return on those contributions; and
• the rate of member-borne charges.

Over the same period since 2004, there have been a number of other fundamental changes to the concept of pensions and retirement. Various regulatory authorities have increased the standards of governance, and reduced member-borne charges, in workplace DC schemes. Workers can now access their retirement savings while continuing to work, effectively turning retirement into a 'process' rather than an 'event'; and, more recently, the Freedom and Choice agenda has allowed workers to access their pension savings from the age of 55 without necessarily using them for retirement purposes.

Workplace saving on a soft compulsion basis, as provided for through auto-enrolment, is a sound enough principle. But, if we could relive the past, would we enrol workers into DC pension savings schemes? One could make a good case for saying that pension savings, as traditionally understood, make no logical sense now that retirement is such a gradual process and those savings do not need to be used for retirement purposes. Perhaps, with the benefit of hindsight, workers always should have been auto-enrolled into 'ISA-style' arrangements, but with the Freedom and Choice regime governing access.

Practicalities

To protect workers, these new DC ISAs would need a charges and governance regime to guard against poor value - but the basis for this regime already exists. Employers would need to go to the trouble of putting in place a new workplace benefits system, having only just gotten to grips with auto-enrolment. Providers would need to 'mothball' their auto-enrolment schemes before they have broken even, let alone made a profit, and to invest further in the design, build and distribution of new DC ISAs.

This would all be far from straightforward.

In reality, we cannot turn back the clock – and, perhaps, we do not really need to. One could make a very strong case that the legal and regulatory developments since 2004 have already set us up for a successful savings future. The current regulatory regime, in conjunction with advice and guidance software to help good member decision-making, creates a sound platform for our savings future. Once the expected increase to minimum auto-enrolment contributions takes effect after 2018, we can sit back and watch savings grow in well-governed, good value schemes which facilitate good member decision-making.

Changing the system

If further change is to be implemented, it does need to be implemented on terms which suit workers, employers and providers as well as the tax man. We do not need to rewrite the rule book in order to do this - we simply need to learn from experience.

If the decision is taken to reinvent auto-enrolment following the consultation, let's do so by way of a relatively light touch regulatory regime which gives sufficient leeway to align any new legal requirements to the reality of existing payroll arrangements. We also need a commitment about how long this new system will be given before it can be tinkered with - if we really want the UK pensions market to flourish we need savers, employers and the industry to be confident that they are all investing for the long term.

Tom Barton is a pensions law expert at Pinsent Masons, the law firm behind Out-Law.com. This article is part of a series dealing with the government's pensions tax relief consultation, Strengthening the Incentive to Save, which closes on 30 September 2015.