Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is an FT contributing editor
Reforming the UK pension system has been a long history of fits and starts. Some 17 people have held the job of pension minister since 1998. But a head of steam is at last building up. Given that the UK has the third-largest stock of pension assets in the world, that is badly needed.
While pension assets are substantial, the landscape is incredibly fragmented. The UK has over eight thousand pension schemes — and that’s ignoring the tens of thousands of “micro” ones. A lack of scale makes investing in infrastructure and venture capital prohibitively expensive for most. Consolidating scheme assets to tackle this was central to changes dubbed the “Mansion House reforms”, brought in by former chancellor Jeremy Hunt last year. The Pension Schemes bill just introduced in the King’s Speech looks very much like the new Labour government taking forward Hunt’s work.
First up, so-called “value for money” tests will now be applied to defined contribution schemes. The idea is that funds that compare poorly on cost and investment returns will be forced to wind up and transfer their assets to those that do better.
Second is a plan to extend pension funds’ duty of care into retirement. New autoenrolled pension contributions currently flow overwhelmingly into master trusts — pooled funds that have professional independent trustees with a fiduciary duty of care. As things stand, default pathways guide members through savings while in their jobs. But at retirement, people can find themselves transferring their pension assets into a poor value retail product. By extending trustees’ duty of care into retirement, it’s envisaged that pension members will get better outcomes, and that the broader benefits of consolidated pension pools will last longer.
Third, defined benefit schemes will now be better able to consolidate through so-called commercial superfunds. This overdue legislation will complete a process that began over eight years ago.
Despite these steps, the new government’s approach still seems evolutionary rather than revolutionary. As Sir Steve Webb, partner at LCP and a former pensions minister says, “this is the quick bill — deeper thoughts are to come later”. Labour made a manifesto commitment to conduct a holistic pensions review. So, what deeper thoughts might this include? Various radical possibilities jump out.
While autoenrollment has been the major pensions achievement of the last decade, contribution rates at 8 per cent of salary are still low. Minimum contributions in Australia and Sweden are around 12 and 18 per cent of salary, and New Financial — a capital markets think-tank — estimates that 20 per cent or more is typical for Canadian and Dutch workers.
Next, chancellor Rachel Reeves has stated she has “no plans” to change tax relief on pension contributions. HMRC estimates that reliefs — currently tiered to match marginal income tax rates — cost over £48bn net each year. According to a report by the Pensions Policy Institute in 2020, around three quarters of these go to higher rate taxpayers. A shift to a single rate of tax relief could be revenue neutral, substantially boost incentives for lower income workers to save into their pensions, and increase the proportion of the relief they received. However, according to the Pensions and Life Savings Association, such a change would be require a multiyear overhaul of payroll systems, so would require a long lead time.
Third, the Local Government Pension Scheme has a substantial asset base of over £425bn. But fractured as it is across 86 administering authorities, it is denied the benefits that its scale should bring. Moving assets into a single pool would create a globally significant fund and deliver huge savings. Of course, stripping local authorities of their asset allocation and oversight powers could prove politically challenging, but it is a fight worth having.
Finally, the UK should look abroad for inspiration. Investing public service worker pension contributions in productive assets could save taxpayer money, deepen capital markets and boost national savings. The Canadian and Swedish governments have demonstrated how to make this transition. We should follow them.
Some readers will probably be paying close attention to changes to the tax-free inheritability of defined contribution pension pots. The Institute for Fiscal Studies has called out the current treatment as “indefensibly generous” for years. Under today’s system it can make sense for those with large assets they wish to pass on to fund their retirement by remortgaging rather than drawing down their pension. This is insane and something for Labour still to tackle. While this pensions bill will ruffle few feathers, the next one could be even more interesting.
