The private-sector workforce has undergone a seismic shift in pension provision in recent years. Businesses are migrating away from the final salary model of heavily guaranteed pensions towards a newer defined contribution (DC) style of pension. The problem – and the challenge – is that this new model is deeply flawed.
These DC pensions can be very inefficient and wasteful, and are set to leave too many people with measly incomes in their retirement. Around five million people save into a DC pension, but that figure is set to skyrocket from October with the introduction of auto-enrolment reforms that will eventually bring up to nine million workers into a pension.
It’s a huge step forward and one that this country badly needs, but we worry that many of the pensions themselves are not up to the job. The challenge for the industry is to show people that they are.
Partly it’s an issue of scale. The UK has 42,000 workplace DC pensions and the average scheme has just 20 members, which creates huge inefficiencies and high administration costs. That’s why we have been arguing that we need to supersize pensions, creating new types of schemes which we call supertrusts.
Information about DC pension costs and charges is also far too unclear and is something that savers are worried about. We are trying to create a new industry code of practice to make things simpler. People need to be able to understand their pension charges by seeing a figure in pounds and pence, instead of a web of baffling charge structures.
Annuities are another problem area. A DC pension pot can be used to buy an annuity to provide a regular retirement income. At the moment it is far too difficult for people to find the best annuity deal and the majority go with the default offer made by their pension provider. This failure to shop around for a better deal can wipe 30 per cent off their annual pension, and is something the industry and the government are looking to improve.
Finally, many people start a DC pension with each new job, which leaves the average worker with too many pension pots following them around. They either forget about these different pots or find it difficult to pool them together. This can leave pensions dormant in low-performing funds or being eaten away by high charges.
The good news is that all these issues can be tackled and that the industry is well aware of them. Our research shows that public confidence in pensions is at a record low and that too many people are failing to save anything for their old age. If auto-enrolment is to work, we have to reverse that. There’s too much at stake.