The grand-daddy of all pensions

Every person in work, whether employed or self-employed, earning above a minimum weekly amount, will be required by law to contribute to a national pension scheme, unless they are already a member of an occupational pension scheme or are paying at least equivalent contributions into a personal pension.

This is one of the important recommendations published this week by the Retirement Income Inquiry - an independent body sponsored by the National Association of Pension Funds, which for the past two years has been reviewing pension provision in the UK.

It has received a cautious welcome from both sides of the political fence, but could well cause a storm when the implications for individuals and employers are fully understood.

The scheme would rapidly replace Serps, the cost of which falls largely on the taxpayer. But the prospects of a third compulsory deduction from pay packets on top of income tax and National Insurance may well be unpopular with individuals who presently rely entirely on state pensions.

Contributions would be 4.8 per cent of earnings - the present Serps rebate - between an upper and lower limit on earnings and be split between employee and employer in the case of the employed. But the inquiry also recommends that this contribution rate should be progressively increased to reach a more realistic rate that would provide an adequate pension. A contribution rate of at least 10 per cent of earnings has been put forward as the minimum rate required if individuals are to receive a pension of 50 per cent of earnings. An additional contribution of up to 0.7 per cent of earnings would also be needed to fund the transition period while Serps was being phased out.

Individuals could still contribute to personal pension schemes but the national pension scheme could well reduce the role of portable schemes because few employers contribute to employees' personal pension schemes but they would be compelled to contribute to the national scheme.

Contributions paid by each individual would be invested in a variety of assets, mainly equities, accumulated in separate individual funds until retirement when the accumulated value would be used to buy an annuity to provide the pension for the individual.

As with portable pension schemes, the ultimate pension received by individuals from the proposed national pension scheme cannot be guaranteed. The amount will depend on how successful the trustees are in investing the assets (presumably the investment management will be delegated to professionals if only to avoid problems with the Financial Services Act) and annuity rates at the time of retirement, over which trustees have no control.

This is in contrast to Serps and company pension schemes, where the pension ultimately received depends only on an individual's earnings during his or her working life and is therefore independent of stock market/property market performance and of interest rates.

The pitfalls in a scheme dependent on investment performance are many and often unseen until too late. The ultimate pension received by individuals in similar circumstances will vary simply because investment returns were different over their working lives and, equally important, annuity rates were different when the pension was bought.

The objections to the national pension scheme from individuals could well include being made to save towards their pension, particularly if the contribution rate is high and they are under financial pressure such as meeting mortgage commitments, having no control over the investment of those contributions and experiencing a fall in value when the equity market falls, and being utterly confused over buying the annuity at retirement. Men may object to women receiving equal annuities because women live longer than men.

If the ultimate pension from the national pension scheme turns out to be low at a particular time because of adverse investment performance and/or low annuity rate, there is almost certain to be a massive outcry to make up those pensions from the public purse.

Finally, the inquiry is proposing to end payment of tax-free cash sums from pension arrangements - a logical proposal, but in itself certain to ensure total hostility by the public.

This scheme will do nothing for existing pensioners on low pensions. The inquiry proposes therefore that there should be a first-tier assured pension equal to the present basic state pension plus a top-up pension to bring the total to a minimum of 20 per cent of national average earnings. This would represent the absolute minimum pension payable.

The basic element of this pension would be paid to all. But the top-up would be means-tested and progressively cut the higher an individual's overall income (capital would be ignored). This proposal may meet equally violent opposition on the grounds of means-testing, though everyone would have to provide income details before receiving the pension. Any reduction on the top-up will also upset people who claim that, because they have paid the full National Insurance contributions, they are entitled to the full pension from the state. Assured pensions will also mean substantially higher National Insurance contributions.

Someone, however, has to grasp the nettle and educate the public in the basic lesson that nobody can repeal or change the laws of economics. Higher pensions can only be paid for by the working population whether through higher taxes, or accepting lower earnings so that equity dividends can be increased to pay pensions, or both. The alternative is lower benefits.

Many countries are finding this a very difficult message to get across to a hostile public. But it has got to be done, and the sooner the better.