Consensus continued?: The next stage of pension reform

Introduction

The last 15 years have seen impressive cross-party consensus on pensions policy, particularly the establishment and extension of auto-enrolment into workplace pensions. This has led to improvements in retirement savings and incomes. But further reforms are required to ensure more people have sufficient resources for retirement.

Bright Blue and the Fabian Society, two think tanks representing the intellectual right and left, have a track record of coming together to find common ground and practical answers on pressing policy problems. In this project we sought to explore the scope for a cross-party agenda for the next stage of pensions reform.

Late last year, on the eve of the government publishing its latest review of auto-enrolment, Bright Blue and the Fabian Society published the first output of this project: an essay collection, entitled Saving for the future, with contributions from leading decision-makers and opinion formers from different political and professional backgrounds. This examined their priorities and ideas for future reforms to pensions.

Building on the thinking from Saving for the future, this paper is the second part of the project. Over the past few month, the Fabian Society and Bright Blue have been seeking to understand where Labour and Conservative party politicians and policymakers agree and disagree on pensions policy. We wanted to understand the extent to which it will be possible to renew and extend the consensus on pensions. Our conclusions are based on a review of recent public statements and a series of private conversations.

The paper highlights convergence and divergence in thinking on pensions policy between the two main political parties in five key areas: auto-enrolment; support for the self-employed; tax relief on private pensions; the state pension; and the ‘pensions freedoms’. Our judgement is that, while there are clear philosophical and policy differences, in all these areas at least some cross-party consensus can be achieved for ambitious and necessary reforms to pensions.

Auto-enrolment

Automatic enrolment was devised by the Pensions Commission in the mid-2000s under a Labour government and introduced by the Coalition and Conservative governments over the course of this decade. It is a broadly successful and popular policy that attracts support from across the political spectrum.

Its origins lie in ‘nudge theory’, which – based on insights from behavioural science – suggests that individuals can be guided to better decision-making without losing ultimate control over their choices. The most obvious manifestation in public policy is the use of opt-out schemes, such as pensions auto-enrolment, where individuals are automatically defaulted into what is judged by politicians and policymakers to be the best option for them, but with the ultimate power to choose an alternative. This policy approach satisfies the political right, by enabling individual autonomy, and the political left, through its paternalistic focus on optimising outcomes.

It doesn’t just work well in theory, but in practice too. Auto-enrolment into workplace pensions has been highly successful, with an estimated ten million workers newly saving or saving more in 2018 because of its introduction. Private pension participation has increased from a low of 55% in 2012 to 78% in 2016. Opt-out rates, originally forecast to be 15-20%, are estimated by the government to be under 10%, albeit with variations by age, gender and working pattern.

Following the current Conservative government’s review of the policy, published at the end of last year, ministers announced that auto-enrolment will be extended during the 2020s by lowering the minimum participation age from 22 to 18 and abolishing the lower earnings limit of £5,876 from which pension contributions are calculated. They also reiterated their commitment to achieving 8% minimum contributions by April 2019, of which 3% must come from employers.

These latest government decisions have been welcomed by the Labour party, but the Opposition is also keen to explore how to raise the minimum contributions beyond 8% over time. This is because contributions at this level are widely deemed to be inadequate for a comfortable retirement. Labour and the trade unions, however, recognise that any increase in employee contributions should be gradual, especially while earnings growth is relatively low, to stop people seeing a fall in their take-home pay. Some on the political left would like to see the UK system gradually evolve into something closer to Australia’s which is based on compulsory employer contributions of 12% irrespective of the contribution employees choose to make. Significantly higher employer contributions could be unpopular with businesses – although concerns may be ameliorated if contributions rise very gradually over a long period and if employers can factor these increases into the pay rises they give to their staff.

The Conservatives recognise that an 8% contribution to a workplace pension is likely to be insufficient for a retirement income, but also believe it would be wise to reflect on employer attitudes and employee drop-out rates once 8% minimum contributions are reached next year, before committing to further changes. There is a fear that moving too fast and far with auto-enrolment could undermine its popularity and success. There is also some scepticism among Conservative decision makers and opinion formers about asking people who are young and on squeezed incomes to save a large and growing proportion of their salary into a pension. This ties-up money that could be used for emergencies or saving for a deposit to buy a house, which are likely to be more pressing needs for these social groups.

Once 8% minimum contributions are achieved in 2019 there is an opportunity for left and right to explore, be innovative and find consensus in the next stage of auto-enrolment. This could address not only the level of future minimum contributions for different types of employers and employees, but whether there should be more fungibility in how savings above the 8% contributions can be deployed. There is interest among all political parties in ‘sidecar’ accounts, which take a certain proportion from auto-enrolment contributions and could enable people to access liquid savings for shorter-term costs. There is also strong interest, especially from Conservatives, in how new tech-based products could interact with future auto-enrolment savings and produce more informed and discerning savers.

There is also a degree of consensus between the two political parties on the need for pension funds to be better governed and consolidated to achieve greater stability. Labour politicians would ideally like to see all pension schemes have trustees. The Conservative government, meanwhile, would like to increase the power and scope of Independent Governance Committees, which are currently just advisory bodies to pension funds, so they can set the defaults for funds.

Both political parties are also keen to see larger pension funds. Labour is interested in creating an active requirement for trustees to consolidate if they cannot offer excellent value for money to their members. The Conservative government has been particularly keen on consolidation of local government and defined benefit (DB) pension schemes. In the case of DC pensions, ministers have reduced the bureaucracy that slowed down consolidation and introduced a master trust authorisation regime to incentivise consolidation.

Supporting the self-employed

Recognising that a growing number of people in the modern workforce are self-employed, both Conservatives and Labour have been exploring and committing to better ways of strengthening their relatively weak rights in the labour market. Pension provision forms part of this debate.

The self-employed are not auto-enrolled into workplace pensions and therefore not entitled to minimum employer contributions. Evidence confirms they are saving – and saving for a pension – much less than employees. The Conservative government has committed to testing targeted interventions to establish what works for increasing pension saving for the self-employed.

Labour and Conservative figures are open to a more interventionist approach than at present to support the self-employed save for their retirement. But there is no clarity nor consensus on how to do this. There is strong instinctive support for introducing auto-enrolment for the self-employed via tax returns. But policy makers are aware of the difficulties of implementing this in practice, considering that an already burdened HMRC would be assuming the responsibility traditionally associated with an employer. There might be a case for first testing less statist solutions first. Conservatives have been especially enthusiastic about market solutions: specifically, whether technology can provide products to support and nudge the self-employed to save more, including into a private pension.

There are also political risks. Last year the Chancellor attempted to raise national insurance contributions for the self-employed to reduce the gap between their contributions and those of employees with the same gross income. But the policy was quickly defeated by strong opposition in parliament and the press. There is therefore significant sensitivity around what new rights and responsibilities should be given to the self-employed. This political nervousness clashes with views on what is right in principle. There is a strong cross-party desire to extend more rights to self-employed workers, but many politicians and policymakers in both parties feel that if this is to happen the self-employed must also contribute more in national insurance.

Politicians and policymakers from all parties, especially Labour, are also concerned about ‘bogus’ self-employment, where workers are pushed into self-employment so firms can avoid funding payroll taxes and employee benefits including pensions contributions. Stronger enforcement and clearer case law might draw more workers into the remit of workplace pensions.

Tax relief

There is a broad consensus that a partnership of actors – individuals, businesses and government – all have to fairly contribute to ensure that people can enjoy comfortable retirement incomes. The main way the state currently contributes to pensions accumulation is through tax relief on the contributions made by employers and employees. In England, Wales and Northern Ireland, basic rate taxpayers get 20% tax relief on their pensions savings, higher rate taxpayers get 40%, and top rate taxpayers get 45%. Individuals then pay tax on the pension they receive in retirement. The theory is that pensioners will be taxed at a similar rate to the relief they received when accumulating their pension. In reality many who were previously higher rate taxpayers when in work are basic rate taxpayers in retirement or take large tax-free lump-sums, meaning that the deferred taxation of pensions significantly reduces their lifetime tax liability.

Across the political spectrum, there is a strong belief that pensions tax relief is expensive, poorly targeted and regressive. The ‘headline’ cost of pensions tax relief in 2017-18 was estimated by HMRC to stand at £41bn and while basic rate taxpayers comprised the large majority of the beneficiaries they only received a minority of the total amount of relief distributed. This remains the case even though maximum levels of tax relief have been capped by annual and lifetime allowances. Admittedly, the eventual net cost of pensions tax reliefs will be much lower because the pension income generated by the tax-free saving is taxed later. But it remains true that many high earners will pay less tax on their pension than if the same money had been taxed at the point it was first earned.

In 2015 Chancellor George Osborne therefore considered introducing a universal, flat-rate tax relief for all pensions contributions. This could lead to basic rate taxpayers receiving more tax relief on their pension contributions and higher and top-rate taxpayers less, thereby making the policy more progressive and providing stronger incentives for low and middle income individuals to save for their retirement. Proposals along these lines remain generally popular among politicians and policymakers from all parties, who feel they make sense for simplicity and distributional reasons.

The Treasury is now believed to be nervous of reform of pension tax relief. Certainly the idea has not recently been entertained at the very highest levels of government. This is, in part, because of the potential for a media and political backlash from restricting higher-rate relief, which would focus in particular on the impact on public sector workers and taxpayers who are just above the higher-rate threshold. There are also fears that restricting tax relief for public sector DB schemes might undermine these schemes or require the government to compensate members with higher pay or employer contributions, reducing the scope for government savings. More broadly, the government is nervous of tax reforms that could undermine the sustainability of DB pensions, especially if the overall savings are modest.

Notwithstanding this Treasury view, there is a sense from politicians and policymakers that an opportunity to reform pension tax relief is gradually emerging. In part this is being driven by rising pension saving caused by auto-enrolment. More saving automatically increases the tax relief bill therefore creating pressure on HM Treasury to act. The success of auto-enrolment could in the years ahead provide the Chancellor with a strong fiscal argument to reform pensions tax relief.

The state pension

Today’s policy for the state pension combines reforms initiated by Labour, Conservative and Liberal Democrat politicians so it is no surprise that the parties agree on the general direction of travel. Labour and the Conservatives are both signed up to the eventual end-point: a single state pension paid at a flat-rate, ostensibly based on National Insurance contributions but more-or-less universal in practice. The state pension will essentially become a ‘basic income’ for old age to act as a secure platform for additional saving by individuals and employers. Once fully implemented the new state pension will be set at a rate that avoids the need for means-testing (except for renters) and will be without any earnings-related extras. This provides a clear incentive for most people to save and a simple, stable starting-point for future pensions debate.

Both parties also currently support the ‘triple lock’ for annual increases to the pension, at least in their official statements. However, if this policy stays in place over time the value of the pension will increase relative to earnings (because in bad years for wages the pension will rise by the higher of inflation or 2.5 per cent instead). With median living standards for pensioners now higher than for working-age households it is questionable whether this policy is equitable or fiscally sustainable over the long term. But the two political parties are extremely cautious about abandoning such a totemic policy. Many politicians on both sides would in principle prefer for the pension to increase in line only with earnings if they could make the change without political fall-out. This reform was attempted by the Conservatives in their 2017 general election manifesto but the proposal was subsequently dropped.

The big fight between the parties is on the state pension age. Labour launched the idea of regular increases to the pension age and consented to the last coalition government’s introduction of periodic pension age reviews. But the Labour party has opposed each Conservative proposal to bring forward the date of future increases to the pension age, on the grounds that the government is providing insufficient notice to prepare and is being unfair to poorer people with low life expectancy. At the 2017 election Labour opposed all pension age increases beyond 66 pending a review to explore the feasibility of flexible retirement ages. By contrast, just after the election, the Conservative government accepted recommendations from Sir John Cridland for the pension age a rise to 68 in the late-2030s and ruled out any variability in the pension age.

Among Conservatives, there is no appetite for going beyond the current trajectory for the state pension age. For them, raising the pension age is a question of necessity and morality, considering demographic changes and fiscal pressures. But many Conservatives also now recognise that the future pension age and the recent pace of change is high relative to comparable countries. Labour, meanwhile, will continue to campaign against pension age increases, pointing to the latest data which shows life expectancy increases have slowed.

However there may be some scope for compromise over time.  Conservative ministers have already said that the exact timing of the rise from 67 to 68 will depend on future longevity projections. They also avoided commenting on Cridland’s proposal for making pension credit available early for carers and disabled people and for reducing work requirements for jobseekers in their 60s. And while the idea of variable pension ages, based on life expectancy or occupation, has been ruled out for the time being it is not something that Conservatives have a principled objection to. In coming years politicians of all sides are likely to question the abrupt cliff-edge between universal credit and the state pension system. There may be scope to redesign social security for people in their 60s on a cross-party basis.

Pension Freedoms

In 2014, Chancellor George Osborne unveiled a radical change to pensions policy, with his announcement that people would no longer be required to turn their pension savings into a lifetime income. Many, including Labour politicians, were concerned by the move towards ‘pension freedoms’ from the age of 55, which they felt undermined the principle that pension saving is there to provide for the duration of retirement. On a philosophical level, the ‘freedom and choice’ reforms pitched the political right’s preference for consumer control against the political left’s instincts towards paternalistic and collective solutions. But the move was instantly popular and Labour chose not to directly oppose the policy.

Conservatives recognise that it is too early to ascertain the precise impact of the pension freedoms. When the policy was first introduced annuity sales declined very significantly, though they have now begun to gradually recover. And Australia has not had a wholly positive experience with pensions freedom. But Conservative politicians and policymakers remain adamant that it is a generally positive policy and believe fears that people will over-spend or make poor decisions when they draw down from their pension are exaggerated. They have no appetite for major changes to the new regime they recently introduced.

However, all sides recognise there have been some teething troubles since the introduction of ‘freedom and choice’, especially with respect to scams and misselling. To tackle fraud, the government accepted opposition proposals for a ban on pension cold-calling during the passage of the recent Financial Guidance and Claims bill. Now to prevent misselling it is under pressure to ensure that people considering cashing in a DB pension always receive appropriate advice.

Thinking more long term, issues with freedom and choice do exist. To date most people exercising choice have taken their money as cash. For the time being a good proportion of these pension savers will not suffer permanent detriment because they have alternative sources of income, often from DB pensions. But politicians, especially Conservatives, have been disappointed that the financial services industry has not developed and promoted new specialist products to meet retirement needs. Many observers think a framework is needed in anticipation of the time when DC pension savings are the principle means of funding retirement. Otherwise there is some risk that people will spend their money too fast or (more likely) save too much and not spend down their pension assets during their lives.

Politicians on all sides, including members of the work and pensions select committee, are interested in default retirement pathways that will meet most people’s needs if they take little or no action for themselves. This would replicate the ‘nudge’ approach taken during the accumulation phase with auto-enrolment into workplace pensions. Conservative ministers, however, say they are sceptical about the default approach and suggest it is inconsistent with the principles of ‘freedom and choice’. In practice this disagreement may not be as great as it appears because the Financial Conduct Authority has recently proposed a ‘middle-way’ that would give consumers the opportunity to select between three pathways based on how they want to use their money. This is a step forward for consumer protection. However, Labour politicians are likely to object that none of the three pathways provide a guarantee that people will not run out of money in late old age.

Labour’s main interest is in achieving good retirement outcomes for unengaged savers so the party is likely to place great emphasis on getting future pathways right. By contrast, the priority for Conservative ministers is for many more people to make active choices that are well informed and feel right for them. For this reason Conservatives’ main focus is on promoting guidance before decisions are taken and a pensions dashboard that will bring information on people’s savings together in one place. There is also a lot of interest among Conservative politicians and policymakers in mid-life money ‘MOTs’ – perhaps provided by businesses – as current ‘wake-up’ communications are believed to come too late to help people make good plans. Under the new financial guidance legislation, a single financial guidance body is being created and pension providers must signpost to it before a pension is cashed-in. Conservative ministers, however, have watered-down opposition proposals for pensions guidance to be either taken or explicitly turned-down as they do not want guidance to be mandatory.

Policy in this area will develop as FCA regulation emerges and the government’s new guidance body opens its doors. For one thing, the Conservatives and Labour are equally suspicious of large incumbent providers engineering ways to ensure that their ‘accumulation’ customers transfer over to profitable and potentially unsuitable ‘decumulation’ products. The Labour party’s first instinct is regulation and soft compulsion; the Conservative party’s is to promote choice. But each will be watching the pensions industry warily and they may well both end up supporting a blended combination of choice at retirement and regulated pathways.

The end of compulsory annuities represented a further reduction in risk pooling in pensions. Historically defined benefit (DB) pensions had offered risk pooling in both the accumulation and decumulation phase of a pension. From the 1990s the shift towards defined contribution (DC) saving has ended the former; and now the removal of compulsory annuities has ended the latter. In response Labour is now seeking new ways to revive collective risk-pooling. As well as defending those defined benefit pensions that still remain the party wants to promote collective defined contribution (CDC) pensions, a Dutch model that smooths risks across all scheme members. CDC was championed by the Liberal Democrat pensions minister Steve Webb during the coalition government but the Conservative post-2015 government delayed implementing the law he introduced creating a framework for CDC.

Labour politicians want to see CDC develop as a mainstream alternative to the highly individualistic new pension landscape. By contrast, the Conservatives are inclined to follow employer preferences rather than actively push one model over another. In recent years they pointed to low industry demand for CDC as a reason for inaction. However, that has changed and Conservative ministers are now aiming to bring forward legislation to enable CDC schemes, primarily in response to the Royal Mail and its trade union jointly expressing interest in establishing such a scheme. There is therefore growing interest, even enthusiasm, from both parties for CDC, although also potential for disagreement in the long term about how large a role this model might have relative to conventional DC schemes.

Conclusion

It is difficult in politics to develop cross-party consensus on major public policy questions. But when consensus emerges, politicians and policymakers should be proud not embarrassed. Such consensus has led to necessary and successful reforms in critical policy areas, from climate change to pensions. After 15 years of reforms to pensions, characterised by significant cross-party agreement, it is now time to think about the next steps. There is much more to do to ensure more people have the necessary savings and support for a comfortable retirement.

Bright Blue and the Fabian Society, through our 2017 report Saving for the future and now in this paper, have attempted to bring together politicians and policymakers from the political right and left to extend the consensus on workplace pensions. In particular, we have explored whether there is scope for future reform based on cross-party support across five key areas: auto-enrolment; supporting the self-employed; tax relief on private pensions; the state pension; and the ‘pension freedoms’.

Unsurprisingly, there are important philosophical and policy differences between the parties, which need to be debated publicly. But there are also areas of consensus on what to do next. Some of these ideas are radical, yes, but also necessary. That is why the Conservative and Labour parties should be open to coming together to support them.

In conclusion, our findings are as follows:

• There is continuing cross-party support for auto-enrolment into workplace pensions, including extensions recently announced by the current Conservative government for implementation in the 2020s. Both parties would like to see higher contribution rates over time and while they may disagree about the pace of change there is scope for consensus building. This could include agreement on more fungibility in the spending of savings made through auto-enrolment.
• Both political parties are united in the aim, but not entirely in the methods, to ensure pension schemes are better governed and consolidated into larger funds.
• The Conservatives and Labour are both attracted to auto-enrolment for self-employed workers in principle. But there are political obstacles to developing an HMRC-based system and Conservatives want to test less-statist options first.
• Many Labour and Conservative politicians support the idea of flat-rate pensions tax relief. Chancellor George Osborne considered this reform but it is not a current priority for HM Treasury. The cost of tax relief is rising, however, so the case for change may come sooner rather than later.
• Both Labour and the Conservatives support the design of the new state pension but would ideally abandon the ‘triple lock’ and replace it with earnings indexation if this could be done without political fallout. There is clear disagreement on increases to the state pension age but scope for building consensus on new flexibilities when approaching the pension age.
• Labour is suspicious of the Conservatives’ flagship pension freedoms initiative that gives people control over their pension pot after the age of 55. But it has chosen not to oppose the policy directly. The Conservatives have accepted some regulation to prevent abuses of the new system but their priority now is to promote active decision making and product innovation. Labour will emphasise regulated pathways and are likely to press for these to give unengaged savers the option of a secure lifetime income.
• The Conservative government is introducing CDC pensions in response to emerging employer interest. Labour is going to champion this model as an alternative to the new individualised pension world.