How to improve the new universal pension scheme

It’s been a long time in the thinking but the coalition has finally given the National Employment Savings Trust (Nest), the universal pension savings scheme dreamt up by New Labour, the go ahead. So from 2011, employees will begin to be opted in and some of their salary siphoned off into pension accounts.

Should we be pleased? Sort of. It is good news for employees (if not employers) that everyone will now be able to be in a scheme that offers both work and state contributions (3% and 1% of salary respectively).

And it is good news that the government is aiming to sidestep the way that fees eat into returns by insisting that those who end up managing the funds do so for an annual management fee of 0.3% a year.

But Nest has major problems.

The first is the fact that many savers will still end up with small pots, making their efforts pointless. If saving £50,000 over a working life means that, thanks to means testing, you get no pension credits, you shouldn’t bother sacrificing your current spending for it. And if you get scammed into doing so via auto-enrolment you should be very angry. Cue a mis-selling scandal.

Second is the cost. Once Nest is worth billions, it will be possible to find someone to manage it for 0.3%. When it is less than that, and comes in small pots, it will be tough. And 0.3% isn’t all that participants will have to pay anyway. There’ll be all the usual admin and dealing fees too. The government also intends to claw back the cost of setting up Nest by charging a 2% levy on all contributions for decades to come. Add it all up and it won’t be very cheap after all.

The third is the risk. The odds are that the bulk of any money that workers don’t manage to opt out will be shovelled into the equity markets. Yet not much has been said by the architects of Nest about the general failure of equity investors to make money.

Earlier this year, Tim Price of PFP Wealth Management explained the situation. If you look at the annualised 20-year returns from the UK stock market over the last three centuries, you will see that the results cluster around an average long-term return. That’s pretty much as expected. What is not as expected – and what I assume the Nest architects do not know – is that “the median real annual return from UK stocks broken down into smaller 20-year durations is approximately zero”.

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The past is no guide to future performance but 300 years’ worth of data should be enough to offer a hint of the likely outcome of the next 30. Which rather suggests that forcing people to give you money, which you then invest in the market on their behalf while telling them that it will demonstrably increase their wealth, might be little less than idiotic.

Still, we do need people to save for their futures and we have to start somewhere. So what can we do to make Nest better?

First, deal with the means testing issue. The flat-rate, non-means-tested pension of £140 a week currently being floated as an idea in Westminster would go some way to sorting that out (note that the state currently guarantees a means-tested pensioner income of around £130 for everyone).

Next, make it possible for employees to save rather than invest their money – for example, by putting it into high-rate deposit accounts. With no tax paid on the interest, that might guarantee them a real return – which they need a lot more than the possibility of 0% returns on equity investment.

For those who do prefer to be in the markets, we could follow a very low- cost passive strategy via ETFs following not just equity markets but bond and commodity markets too. The likes of State Street and Barclays Wealth already offer these at low prices.

Finally, we could find a way of paying the upfront costs of Nest without charging them to new savers. I’d be tempted to look to pension tax relief for this. I still cannot understand why the taxpayer is forced to subsidise anything but the most basic of pension savings.

Surely the point of encouraging people to save is to prevent them being a financial burden on the state in their dotage? That suggests an income of around £20,000 absolute tops. Subtract the state pension from that and we surely only need to subsidise pension savings to the extent that they pay an income of about £15,000 a year, or a total pot of no more than £500,000.

Yet at the moment the new cap on pension pots is set at £1.5m. Generate a yield on that of 3% and you’d collect an income of £45,000 without even running down capital – all subsidised by the tax payer. That makes no sense. We should cut it immediately and use the savings to cover the set-up costs of Nest.

None of this will make the scheme perfect. But it might go some way to making it acceptable for those forced into it in the early years.

• This article was first published in the Financial Times


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