Personal Finance: Stake your claim to a secure future

Windy rhetoric, or a genuine boost to millions of poorer people? When the Government announced its plans for a new system of stakeholder pensions recently, opinion on their likely effectiveness was mixed. Here, we explain some of the most important aspects of the proposals.

What kind of a system do we have at the moment?

It consists of a hotchpotch of overlapping types of provision. There is the state pension; there is the State Earnings-Related Pension Scheme (Serps), which is linked to earnings; there are company pension schemes and there are private ones. Someone could quite easily end up with a slice of pension from each of these sources. Meanwhile, the value of a combined state pension and Serps is expected to fall.

Why was change needed?

All political parties say that reform is necessary. The current system is in a mess. The number of people in retirement, compared to those in work, is rising fast and will continue to do so for the next 30-40 years. The Government argues that it cannot afford the rising cost of state pensions.

While the value of pensions paid on retirement is expected to grow in line with earnings, this will not be shared equally; the richest fifth of pensioners will grab a bigger slice. Poorer pensioners will therefore slip even further behind.

So what is the Government planning to do?

In essence, it will improve retirement incomes for the worst off, those earning below pounds 9,000 a year, while using a mixture of financial incentives and coercion to "persuade" the rest of us to go private.

How will this happen?

In place of the current system, whereby from April a single pensioner receives pounds 66.75 a week and couples get pounds 106.70 basic pension, they will receive Minimum Income Guarantees of pounds 75 a week and pounds 119 a week respectively. At the same time, Serps, which was supposed to underpin the basic pension when it was launched in 1978, will be closed to new entrants, in favour of a new State Second Pension (SSP).

What will the SSP be like?

The SSP will become a flat-rate scheme after five years. In return for National Insurance contributions, those earning pounds 3,300-pounds 9,000 a year will receive a top-up to their basic pension of pounds 50 a week. Carers at home, and the disabled, will receive credits as if they had earnings of pounds 9,000.

While the new SSP will assist those earning below pounds 9,000, the Government hopes to reduce its attractiveness for those earning between pounds 9,000 and pounds 18,500.

How?

Basically, by offering National Insurance rebates to those who opt out of the SSP (the old Serps). Because it will be a flat rate, the benefits of staying in the second-tier pension will taper off to very little the more money you earn.

It will make more sense for people to belong to an employer's occupational pension scheme, as almost 6 million do already. These will receive tax rebates, as at present. Or, people will be able to take out a stakeholder pension.

Ah, stakeholder pensions, Labour's "big idea". How will they work?

The Government says there are about 5 million people earning pounds 9,000-pounds 20,000 a year who do not save for retirement. They will receive generous rebates if they put money into a new stakeholder pension.

Up to pounds 3,600 a year (tax-free) can go into a stakeholder pension, which can be offered by any organisation, including trade unions, financial services companies and employers. Scheme members will be able to make contributions for up to five years after they stop working - a boost to those, mostly women, who take career breaks.

Employers will be required to provide stakeholder pension schemes for their staff, although they don't have to make contributions into one. They will also be allowed to join together, and set up similar schemes based on occupations and trades. But they will have to consult with staff as to which provider to choose.

Why will stakeholder schemes be better than occupational schemes?

Employers will still be able to offer occupational schemes - and if they do, they don't have to offer a stakeholder pension. Occupational schemes will be better for many employees - particularly those whose contributions are likely to be above pounds 3,600, the maximum payable into a stakeholder scheme. For those likely to pay in below this threshold, and part-time or temporary workers, stakeholder schemes may be better - as long as employers contribute.

The Government suggests that in such cases, employers may want to have a two-tier system, offering both schemes side by side. Depending on your earnings, it will make sense to belong to one or the other.

Will they be better than personal pensions?

Here, the Government argues that stakeholder schemes will be vastly superior. In common with personal pensions, they will be money-purchase arrangements.

They will be simple to understand and subject to tight regulatory controls - much cheaper than existing personal pension contracts - and you won't have to pay for "advice" when taking one out.

Stakeholder schemes ought to replace personal pensions for most people earning less than pounds 20,000 a year. But for people earning more, the picture changes.

Why?

Mainly because of the pounds 3,600 cap on contributions. The more you earn, the more you need to pay to ensure a proportional income in retirement. Moreover, as you become older, the proportion of income you ought to place in a pension scheme grows. Personal pensions, if cheap, will still offer good value.

So what should I do now?

The Government's proposals are still at the consultation stage. Even so, there's no sense in waiting until stakeholder pensions are introduced: that will take at least a couple of years, and you need to save now.

However, it is highly likely that you will want to transfer your personal pension into a stakeholder one, so you need to find one where the up-front costs are virtually negligible. More on this at a later date.

What if I already have a personal pension?

In some cases, the way charges have already been levied on your contract may not make it worthwhile to transfer. We will discuss this in more detail at a later stage.