Michael Johnson is a CPS Research Fellow and pensions expert. He recently authored the CPS publication "Put the Saver First" and was Secretary to the Conservative Party's Economic Competitiveness Policy Group.
As auto-enrolment (AE) kicks off, in a spirit of muted enthusiasm, attention should be turned to one of the AE-eligible schemes: the National Employment Savings Trust (NEST), a state-sponsored savings vehicle. NEST, facing mounting private sector competition, is uncompetitive, hobbled by several serious structural disadvantages that were imposed upon it as concessions to the vested interests of the financial services industry. These include an annual cap on contributions (£4,400) and the inability to transfer assets in or out (which contradicts Steve Webb’s desire to consolidate employees’ multiple small pension pots). Neither restriction serves any customer purpose: both should be removed immediately (subject to operational considerations).
In addition, NEST’s default fund is excessively defensive, placing an emphasis on lower risk investments in the initial (foundation) stage, contradicting the conventional wisdom that younger investors, in particular, should be exposed to “growth” assets (such as equities). NEST’s explanation is that consumer research pointed to people wanting low risk. This could seriously backfire; the combination of NEST’s 1.8% upfront subscription fee plus significantly negative real interest rates could, in any event, lead to capital erosion. In extremis, a potential mis-selling scandal in the making? NEST’s default fund should be redesigned to take account of inflation, with more emphasis placed on growth assets in the foundation stage. In addition, the state should, if legally possible, write off NEST’s start-up costs to enable the 1.8% subscription charge to be removed; currently it provides a barrier to engagement.
Finally, given their popularity, ISAs should be included in the auto-enrolment legislation, as an alternative destination for employee contributions. To ensure funds retention, the allied tax relief and employers’ contributions should go into NEST or some other pension savings vehicle. Behind this proposal is the observation that ISAs are increasingly being viewed as the retirement saving product of choice, in spite of ISA subscriptions being ineligible for up-front tax relief. In 2010-11, subscriptions to Stocks and Shares ISAs (£15.8 billion, up 26% on the previous year) exceeded, for the first time, subscriptions to personal pensions (£14.3 billion, marginally down on the previous year). It is evident that the bribe of up-front tax relief is increasingly insufficient to overcome pension products’ lack of flexibility. Furthermore, the ISA brand enjoys a trust advantage over pension products. And, unlike pension-derived income, ISA draw-downs are free of income tax.
Meanwhile, the experiment that is auto-enrolment could develop into being merely an interim measure. It is quite possible that the cranking up of auto-enrolment could coincide with rising interest rates, which would squeeze disposable incomes, particularly amongst auto-enrolment’s target audience of low to middle range earners. This would raise the prospect of a rapid rise in the opt-out rate (to above 35%, say), perhaps prompting the Government (irrespective of its political hue) to move beyond “nudging”, to “shoving” i.e. compulsory saving. Indeed, auto-enrolment is to “nudge” what compulsion is to “shove”.