UK Pensions manifesto

How much longer will the State, when financial innovation is running rampant, restrict itself to providing in essence a poverty-prevention pension financed by gilts? And to what extent will it leave its ill-equipped citizens to face the often bewildering complexity of financial products on their own, when they try and secure an adequate retirement income from private savings? We propose to establish a National Pension Manager to harness the nation’s financial expertise for the benefit of each and every one of its citizens.

The Pension Manager will consolidate all new and existing pension schemes under its responsible control, liaising on behalf of the beneficiaries with the financial services industry for the management of this single National Pension System. The consolidation and specialisation in the hands of an expert committee will result in a drastic reduction of implicit and explicit investment management expenses, as well as of the hidden costs due to lack of persistency or contract proliferation. Marketing expenses and dubious sales practices will be entirely eliminated. The System allows furthermore for an optimal and efficient diversification in the global financial markets and capital goods markets, with an expected long-term return exceeding the growth rate of the nation. Crucially, the Pension Manager can now adopt a long-term consolidated assets & liabilities management. This approach will enable the Pension Manager to transcend the rather naive individual annuitisation at retirement, to plan for contingent Pension Credit expenditures or to eliminate the risk of discretionary “leaking” of pension surpluses to early retirees during favourable phases in the financial-economic cycle.

Large-scale financial engineering will permit the National Pension System to provide an adequate guaranteed retirement income for a range of income levels — from a poverty-preventing base pension up to a high-earners’ threshold. (Means-testing will become obsolete.) The “tranches” will resemble brackets of cumulative contributions during the individual’s active career; adequacy for each level is defined by a progressive income replacement rate or, more accurately, a consumption replacement rate net of contributions. Retirement income will be — and remain — linked to national earnings with a minimum indexation in line with prices, to let each citizen profit from progress before and during retirement. In addition, all tranches could benefit from any investment outperformance over the aggregated guaranteed income.
The tranche a particular citizen belongs to, will depend on his/her and his/her employers’ contributions to society, whether in the form of taxes, social insurance contributions or individual savings that “top up taxes”. The State will fund the National Pension System in the amount of a fixed percentage of GDP, thus building in an affordable link with the nation’s prosperity and taking responsibility for low-earners like carers that contribute to society in a more qualitative way. Importantly, the implicit incentive to pay more taxes is primarily  intended to encourage people to work longer. The System will furthermore induce higher savings by setting the guaranteed income at a progressively lower level relative to the adequate tranche level, taking due care that this deliberate “savings gap” is communicated clearly and remains within reach for each tranche. Employers’ contributions will consist of fixed employee pension contributions as well as a variable share linked to corporate cash earnings. Conversely, employers can receive a tax refund in proportion to their contributions out of the outperformance of the National Pension System’s investments over the total guaranteed income.

The funding of the single System with “mixed” contributions removes any inequality arising from the focus on work-related contributions in the traditional fragmented occupational model. In particular, it allows each citizen to assess the trade-off between retirement age and retirement income more easily as the new System accepts taxes, contributions and savings indiscriminately. Similarly, non-working women can accrue pension entitlements through an appropriate processing of their and their partner’s joint Tax Returns. The individual citizen will, of course, retain the right to redirect (part of) his/her savings into an alternative private plan outside the National Pension System; the National Pension System tries to embed the voluntarist approach into a more comprehensive — not strictly compulsory — framework, that is efficient and easy to understand.

The National Pension System will, next to the Pension Manager, feature a Pension Office dedicated to the communication with the nation’s citizens. Its mission consists of facilitating the complex process of long-term financial planning and restoring confidence in the Pension System by providing free, non-sophisticated, unbiased and pertinent information. The Pension Office will periodically inform each citizen of the particular tranche he or she belongs to, the expected retirement income this tranche represents and the amount of savings or (present) employer contributions needed to top up taxes to obtain his or her discretionary target income. The Pension Office will collect data among individuals and employers for, say, the allocation of contingent Credits; it will in this respect coordinate the official data providers to resolve the current data deficiency issues. More generally, the Pension Office will, in association with the authorities, develop financial education and awareness programmes aimed at schools and financially vulnerable population groups.

The comprehensive National Pension System represents a radical change from the intransparent set of rules that constitute the current UK pensions system. Still the transition involves essentially only the creation of a new body of experts to oversee investments and structure the “deal with the nation” to allow all citizens to benefit from financial innovation. The System replaces the means-testing and tax relief “heuristics” with a coherent nation-wide investment approach that is both cost-efficient and easy to understand. By combining individual savings and employer contributions with taxes in a single structure, a carefully considered trade-off between longer active careers and higher savings is promoted. The resulting National Pension System constitutes a concerted approach to fund adequate pensions along the entire income scale that reflect the standard of living now and in the future.

[proposal for the AXA Investment Managers UK Pensions Manifesto Challenge]

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