PPI PENSIONS POLICY INSTITUTE Are Personal Accounts suitable for all? Niki Cleal and Adam Steventon Pensions Policy Institute Supporting members event 29 November 2006 www.pensionspolicyinstitute.org.uk This presentation is intended as a contribution to the policy debate on Personal Accounts. Nothing in this presentation should be used by individuals or their advisors as the basis for saving and investment decisions.
Are Personal Accounts PPI PENSIONS POLICY INSTITUTE suitable for all? • Methodology • Findings • Policy implications 1
Are Personal Accounts PPI PENSIONS POLICY INSTITUTE suitable for all? • Analysed the interaction between Personal Accounts, state pensions, the tax system and means-tested benefits in detail • To identify groups for whom Personal Accounts may be suitable and those for whom they may not be suitable • Used the PPI’s Individual Model: 210 individuals analysed 2
Many factors affect the value PPI PENSIONS POLICY INSTITUTE of saving Value of saving in a Personal Account for a median- earning man with a full NI record aged 25 in 2012 for each £1 of contributions £2.73 £1.00 Individual Tax relief Employer Investment Charges Income tax Pension Council Tax Total contribution contribution returns Credit Benefit + Housing 3 Benefit
Returns from Personal Accounts PPI could be much higher than PENSIONS POLICY INSTITUTE from Stakeholder Pensions Internal rate of return from saving for a median-earning man with a full NI record aged 25 in 2012 0.4% 5.9% 1.6% 3.9% Stakeholder pensions Impact of an Impact of low charges Personal Accounts (AMC of 1.5% for 10 employer (0.5% AMC) years, 1% thereafter) contribution 4
PPI PENSIONS POLICY INSTITUTE Defining ‘Suitability’ • ‘Not losing out’ as a result of saving • Less stringent than ensuring saving in Personal Accounts is the right thing for all • No single definition is appropriate for all, so risk groups used • Based on an ‘Internal Rate of Return’ (IRR) • NOT comparable to interest rates on other products 5
Three risk-categories are PPI PENSIONS POLICY INSTITUTE used, based on the IRR Gets back own plus plus plus plus contributions + Investment Investment Tax Employer inflation returns returns on relief contribution TR + E’er Low-risk 7% ? ? � � Partial 6% 5.5% = investment returns Medium-risk 5% 4% � � � � � � Partial 3% 2.5% = inflation High-risk 2% � � � � � � Partial 1% 6 0%
PPI PENSIONS POLICY INSTITUTE Low risk Medium risk High risk 7
Individuals in their twenties in PPI PENSIONS POLICY INSTITUTE 2012 with full working histories could be in the low-risk category Estimated IRR for men with full NI records and no retirement saving other than Personal Accounts, aged 25 in 2012, by decile of the male earnings distribution 6.8% 7% 6.0% 5.9% 5.9% 5.8% Low risk 6% 5% Medium 4% risk 3% 2% High risk 1% 0% 1st 3rd Median 7th 9th 8
PPI PENSIONS POLICY INSTITUTE Low risk Medium risk High risk 9
Returns can be lower for PPI people with lower earnings PENSIONS POLICY INSTITUTE and career breaks Estimated IRR for men and women aged 25 in 2012, for different levels of earnings and work histories 7% Low risk 5.9% 5.8% 6% 4.8% 4.8% 5% Medium risk 4% 3% 2% High risk 1% 0% Median-earning Low-earning man, Low-earning man, Low-earning man, full NI full NI record intermittent woman, caring record unemployment breaks 10
Personal Account returns can PPI be higher for people who PENSIONS POLICY INSTITUTE have other forms of saving Estimated IRR for men and women aged 25 in 2012, for different levels of saving on top of Personal Accounts 7% Low risk 6.0% 6% 4.8% 5% Medium 4% risk 3% 2% High risk 1% 0% Low-earning woman, caring Low-earning woman, caring breaks breaks, £35,000 of saving on top of Personal Accounts 11
Returns from Personal PPI Accounts can be lower for PENSIONS POLICY INSTITUTE today’s older workers Estimated IRR for median-earning men with full NI records of different ages in 2012, with no retirement saving other than Personal Accounts 7% Low risk 5.9% 5.8% 6% 5% 4.3% Medium 4% risk 3% 2% High risk 1% 0% 25 40 55 12
Self-employment can lead to PPI PENSIONS POLICY INSTITUTE lower returns Estimated IRR for median-earning men with full NI records and aged 25 in 2012, with no retirement saving other than Personal Accounts 7% Low risk 5.9% 6% 4.7% 5% 4.3% Effect of Mainly 4% Medium no 3% effect of risk e’er cbn S2P 3% 2% 1% High risk 0% Employed and saving Not voluntarily Voluntarily opting-in in a Personal Account opting-in to Personal to Personal Accounts throughout working Accounts after age 40 from age 40 life Self-employed from age 40 13
PPI PENSIONS POLICY INSTITUTE Low risk Medium risk High risk 14
Renting in retirement can PPI PENSIONS POLICY INSTITUTE lead to very low returns Estimated IRR for median-earning men with full NI records and aged 25 in 2012, with no retirement saving other than Personal Accounts 7% Low risk 5.9% 6% 5% Medium risk 4% 3% 2% High risk 1% 0.2% 0% Owns his own home in retirement Rents in retirement 15
Who is at risk of PPI PENSIONS POLICY INSTITUTE finding PAs unsuitable? • Low-risk: Single people in their 20s in 2012 with full working histories • Medium-risk: • Single people in their 20s in 2012 with low earnings and broken working histories (whether because of caring breaks or unemployment) – unless they have other savings • Single people in their 40s and 50s in 2012 with low earnings and full working histories • Single people in their 20s in 2012 who stay opted-in to Personal Accounts while employed, and then later become self-employed • High-risk: Those who are likely to rent in retirement 16
PPI PENSIONS POLICY INSTITUTE What other factors could affect suitability? • Risk is lower for people who are likely to be married in retirement • Consumption smoothing – individuals might otherwise face low retirement incomes • Debt – levels of secured and unsecured debt are historically high • Affordability – will depend on individual preferences on current expenditure and saving 17
PPI What does this mean PENSIONS POLICY INSTITUTE for policy? • Even if Personal Accounts are not suitable for all, it does not necessarily mean that individuals should not be auto-enrolled • But should help inform the type of information supplied to help decision making • Some factors may be more problematic than others: • Current age, earnings and debt • Future marital or housing status • Affordability • The design of information may need to change over time 18
PPI PENSIONS POLICY INSTITUTE Next steps? • Can generic advice cover everything sufficiently? • Is there a need for more radical solutions (e.g. not auto-enrolling some groups)? • Should trivial commutation levels be changed? 19
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