As the government rebrands its personal pensions scheme as NEST (National Employment Savings Trust), industry experts are warning savers not to wait for the new workplace pension scheme, which will not be fully operational until 2017.

Pensions experts at the funds management company Hargreaves Lansdown have warned that employees who wait 7 years more for a NEST pension (formerly known as the Personal Accounts Pension Scheme) were losing a considerable part of their eventual retirement income.

“Every year of delay means a lower eventual pension. Don’t wait for your employer or the government to take the intiative, start saving for retirement today,” said Tom McPhail, head of pensions research at Hargreaves Lansdown.

While enrolment of workers into NEST pensions will begin in 2012, it will be rolled out gradually, with the last employees due to be included in 2017.

As the official government occupational pension scheme, NEST consists of an employee contribution of 4% of salary plus an employer contribution of 3% of salary, and a further 1% in tax relief.

Flaws in the government’s planned ‘Personal Account’ pension scheme have been highlighted by new quality standards for company or occupational pension schemes from the National Association of Pension Funds (NAPF).

NAPF has created a Pension Quality Mark based on criteria which define what a good pension should entail.

The Pension Quality Mark will be awarded to defined contribution occupational pension schemes which meet the following criteria:

• Employee contributions of 10% of salary and employer contribution of 6%
• Administration and funds management charges limited to 1% of the main funds
• High levels of clarity and ease of understanding in communications to pension fund members

The criteria which underpin the government’s proposed Personal Accounts Scheme fall well short of the above quality levels. The government’s pension scheme postulates statutory minimum contributions of just 4% of workers’ salaries plus an employer/company contribution of 3%, with 1% in tax relief on top.

Companies with pension schemes that have already qualified for the Pension Quality Mark include Marks & Spencer, Standard Life, Kellogg’s, and IBM.

An even higher quality standard is available from NAPF as well. The Pension Quality Mark Plus will be awarded to schemes where employers contribute 15% of earnings, and their company contributes the equivalent of 10%.

The government’s Personal Account Scheme will be phased in from 2012, and all UK employees not already contributing to a workplace or personal pension will be automatically enrolled into the scheme.

Employers or individuals wishing to avoid the Personal Account Scheme by making their own provision, should request advice from their financial adviser to set up an occupational pension scheme for them, before that time.

The Department for Work and Pensions (DWP) has published a survey of 28 companies with 1-49 employees, which have gone through the process of implementing change in the past.

The research was conducted in anticipation of the introduction of the government’s Personal Accounts scheme (PAS), which will provide a workplace pension scheme for all employees in the UK.

Based on their experience of implementing previous legislation, all 28 of the companies surveyed recommended consulting financial advisers, accountants and software designers in order to assess costs, consider options and upgrade systems.

What will the costs be?

The principal costs they expected from the Personal Accounts Scheme included increased employee participation due to the requirement that all employees be ‘auto-enrolled’ into the workplace pension scheme at the beginning.

Of the companies with a pension scheme already in place, most said they had only partial participation, as pensions were reserved as part of a retirement planning package for company directors and higher salaried staff.

The companies surveyed predicted that in addition to the contributions they would make under the Personal Accounts scheme – equivalent to 3% of each participating employee’s salary – they will also face the cost of upgrading administrative systems to deal with automatic enrolment, and adjusting payroll systems to process contributions and refunds.

*DWP: ‘Understanding small employers’ likely responses to the 2012 workplace pension reforms’

However, with over half the nation not saving towards a pension at all (source: Halifax), most people seem unaware that the traditional streams of retirement income are dwindling. 

It is a full-time job to keep up with the evolution of the pensions scene, with separate developments in the state, public and private sectors coalescing to form the complete picture. 

It is therefore understandable that employees are often unaware of the gradual erosion of their (likely) retirement income from state and employer – and fail to see the urgency of arranging a personal pension, to support a comfortable lifestyle at the end of their working life. 

The Six Sins

 There are six assumptions about retirement planning which are potentially disastrous for pensions savers. These assumptions are based on the realities of previous generations – realities that are now gone forever. 

1 We will have a substantial basic State Pension, as our parents did 

2 We will also have a substantial company pension, as our parents did 

3 There will be strong government support for pensions saving, as our parents had 

4 The size of our retirement fund can be modelled on what our parents did 

5 We can think of our house as part of our retirement planning 

6 The government Personal Accounts scheme is coming 

Each of these six assumptions contains a flaw. Taken together, they demonstrate the need for vigorous and sustained saving into a personal pension plan – which, with 20% government tax relief, is still an unbeatable option. 

The Six Fatal Flaws 

1 ‘Substantial State Pension’: The basic State Pension is now far from ‘substantial’. It has been losing value since it was liked to the Retail Price Index in 1979. It currently stands at under £5,000 per year, and pays out no more than £95.25 per week – and less, if you do not qualify for the full amount. 

2 Substantial company pension? Many private sector employers are shutting down the ‘defined benefit’ pensions our parents enjoyed – household names such as Amex, Pirelli, Costain and Barclays. Defined benefit pension schemes guaranteed a predictable income related to final salary and years of service. These companies are now shifting to less predictable ‘defined contribution’ schemes instead. With a defined contribution pension, your return depends on how well your pension fund was invested, with no guarantee of what you’ll get. In other words, the risk of the investment has been shifted from the company to the employee. 

3 Government support for pensions? The huge explosion in birth rates from 1945 into the 1960s (the ‘baby boom’) has now itself given birth to ‘the Pig in the Python’. This image, of a long python with a large bulge in the middle, depicts all the baby boomers coming along who will be arriving on the retirement scene over the next 20 or 30 years (also known as the ‘demographic timebomb’). Government will be under financial pressures that will make our current ‘financial crisis’ seem like a damp squib – who knows what the future holds for the state pension then. 

4 Size of retirement fund: pensions provision for current and future generations will have to be greater than it was for our parents, because we are living much longer. People are no longer looking ‘old’ at 60 – in fact, we are expected to live into our late 80s. This means we need much bigger pension pots to fund retirements of 20 years and more. 

5 Think of our home as part of our retirement planning: even if you are prepared to sell your cherished home and downscale, the belief in the solid value of property is a legacy of the 1980s boom, and no longer holds water. Average house values have tumbled to £158,000 from £200,000 in this decade alone, according to Halifax. 

6 The Government Personal Accounts Scheme (PAS) will provide: the soon-to-launch Personal Accounts Scheme will give workers a standard pension based on an employer contribution of 3% of gross salary, an employee contribution of 4%, plus 1% in tax relief from government. This is precious little, and for anyone over 40, will have precious little time to grow. To provide context, compare this to the enlightened Swedes, where the basic contributions for their personal accounts scheme start at 16%. 

The conclusion? Starting a personal pension, and saving hard to grow it, is no longer optional – it is essential!

The government’s Personal Accounts Scheme would automatically enrol all employees who have no pension provision into a pension fund after 2012.

The government-backed scheme would be based on an employee contribution of 4% of salary, an employer contribution equal to 3%, and a further 1% in tax relief.

While ‘auto-enrolment’ in the Personal Accounts Scheme is compulsory, employees do have the right to opt out of the scheme if they wish to do so.

New research* shows that only 19% of British adults say they will definitely remain in the PAS, as against 36% who claim they will definitely use their right to actively ‘opt-out’ of the scheme.

Those most likely to actively opt out are in the 35-54-year-old age bracket. This would seem to echo concerns among older workers that the PAS would be of limited value to them, because they are already halfway through their working lives and their savings would have less time to grow in a new scheme.

Ten per cent of respondents claimed they would be unable to afford to make the required payments into the scheme.

Public understanding ‘patchy’

Public understanding of the PAS is still patchy, with 6% of all respondents (rising to 11% among 18-24 year olds) claiming they did not understand the PAS proposals. Another 7% of the population associated the term ‘personal accounts’ with e-mail addresses, and 9% said they had never heard of them.

AXA’s head of pension development, Mike Morrison, commented that this leaves the Personal Accounts Delivery Authority with a considerable marketing job to do, in order to win public confidence and secure the survival of the scheme. 

Morrison also warned that the PAS could also lure savers out of more substantial company pension schemes. 

“The reforms will not be successful if they largely move current and future savings – and savers – from occupational schemes, especially where many of these make total contributions at significantly higher levels than those proposed for Personal Accounts,” he said. 

* Survey of 2110 UK adults, published by AXA November 2009

Latest details from government have indicated that lump sum death benefits provided under the Personal Accounts Scheme would be subject to Inheritance Tax. 

This is a major difference to other company pension schemes, where death benefits are generally paid exempt from Inheritance Tax. 

The news is another reason for employers to consider setting up their own pension scheme, as an alternative to the Personal Pension Scheme, if they do not have a scheme already. 

Inheritance Tax Liability 

Individuals currently have an allowance before Inheritance Tax of £325,000 (£650,000 for a couple), which applies to the value of their ‘estate’. 

The ‘estate’ is defined as the value of all property, savings and insurances, and other assets, less any debts and liabilities. 

Funds above the allowance are subject to Inheritance Tax at 40%. 

The Personal Accounts Scheme

 The Personal Accounts Scheme will automatically enrol all workers not currently saving for a pension. Once fully up and running, employers will pay 3% of an employee’s salary into his pension, with the employee paying 4% and government providing a further 1% in tax relief. 

Certain aspects of the Scheme will impose considerable administration and contributions expenses on employers. In particular, all employees must be registered for the Scheme from day 1 of their employment, which will add significantly to the costs of companies that use large numbers of seasonal employees, as pensions contributions for these employees will have to be paid.

Government plans to assist retirement planning are failing to impress many experts. Meanwhile, changes and cutbacks in company pension schemes mean greater risk for pensions savers there. Taken together, the message is clear. The individual would do well not to depend on the state or his employer any longer, and should certainly be looking at a privately-organised personal pension. In terms of securing a decent standard of living in retirement, the old business mantra holds true: ‘If it’s to be, it’s up to me.’

Government Pension Plans Inadequate

Government’s future pensions provision is a two-pronged approach. First there is the basic State Pension, which is currently just £95.25 per week, or £4,953 per year, having fallen drastically in real value since the link to earnings was broken at the end of the 1970s. This paltry sum is the full basic pension, however, many workers may not have enough years of National Insurance contributions to get the full amount.

Governments second initiative, the Personal Accounts Scheme, will launch in 2012 and aims to save 8% of each worker’s salary into a pension, once it is fully up and running by 2015. Critics claim that as a public sector initiative, the Personal Accounts Scheme is likely to be run on a shoestring, which may limit its ability to access the best investments for the cash. As a result, returns may be less than satisfactory. 

Private Sector: Pensions Risk Shifts to Employee

Many large companies in the UK have begun to withdraw from Defined Benefit pension schemes and towards Defined Contribution pension schemes, effectively leaving the employee exposed to any risk in the investment.

Defined Benefit schemes were good for the employee, as they guaranteed a pension as a percentage of final salary. However, they were risky for the employer, who had to ‘stump up’ the difference to meet payments whenever an underperforming pension fund fell short of its targets. Companies are now moving towards Defined Contribution pension schemes, where only contributions paid in are predictable and fixed. With Defined Contribution, the employee’s pension is based entirely on the return yielded by the fund, with no guarantee. This absolves the employer of any fiscal responsibility, and moves the risk of the investment squarely on to the shoulders of staff.

Companies that have closed their Defined Benefit pension schemes this year include famous names such as American Express, Costain, Barclays Bank, IBM, Fujitsu, and Pirelli.

From 2012, the government will take an initiative in pensions provision to company employees, known as the Personal Account.

Here are the questions to be asked regarding the government’s provisions for retirement planning.

Evaluate what the Personal Account will provide

The government has declared that in 2012 it will introduce Personal Accounts, a pension scheme aimed at those who have neither a personal pension scheme nor a company pension scheme.  Those with neither of these types of retirement provision in place will be enrolled automatically in the scheme (‘auto-enrolled’) . However, since the scheme will be state-run, some experts have predicted that the priority will be keeping running costs to a minimum. This could limit the freedom of the managers of the cash to utilise all the investment options available to them.  Consequently, it has been speculated that the scheme may deliver only mediocre returns to members.

Be alert to the current availability of tax relief on pensions contributions

The government currently provides tax relief on contributions to your company or personal pension. According to current thinking, tax relief would also be available by year three of the Personal Account Scheme (i.e. in 2015) as follows: the employee would contribute 4% of his salary, the employer’s contribution would equal 3% of the employee’s salary, and the government contribution would equal 1% of the employee’s salary.

Be aware of what the basic State Pension provides

The basic State Pension is currently set at the (not so) princely sum of £95.25 per week, or £4,953 per year.

Avail of the chance to fill in ‘missing years’ of NI contributions

If you are reaching or have reached pension age between  April 2008 and April 2015, and already have 20 years of NI contributions, it is now possible to fill in gaps in your NI record for years you missed since 1975. You can ‘buy back’ up to 6 years right away by making voluntary contributions. This option remains open to you for six years from your date of retirement.

Check if you will qualify for Pension Credit

If you have no savings or other income besides the basic State Pension, you may be entitled to Pension Credit. This is a supplement to the State Pension which ‘tops up’ the above figures, but is means-tested and is not available to those who have financial resources of their own, such as bank or building society savings.