Ideal Pension Scheme should include the below and hence avoids the defects of the existing systems. The Ideal Pension Scheme has the following features:
1. It would be fully portable and independent of any employers.
2. Mandatory minimum contribution related to the employee’s salary and possibly age are made into the scheme. These contributions which attract tax relief will typically be made by both the employee and employer. The contribution rates would be set to reflect the pension level desired in retirement which may, for instance, be related to a forecast of salary at retirement. In particular, there should be no incentives in the system for churning customers between different
pension providers,
2 Data on investment returns, salary growth rates, mortality and the volatilities of these would be used
to estimate the value of the fund needed at the target retirement date to purchase the target pension
annuity. Then working backwards an estimate is made of the required contributions into the scheme.
Clearly the later the starting age the higher the contribution rate. Confidence intervals could also be
estimated, indicating the probabilities of different contributions rates delivering the target pension.
3. Individuals would also be required to buy some related pension benefits such as disability benefits (up to a minimum threshold) and would have options for other benefits such as death-in-service benefits and a spouse’s pension.
4. Both the employee and employer would be free to contribute additional voluntary contributions. Contributions in excess of specific employee and employer limits would not attract tax relief, however. There would be parity of treatment with the employer’s own scheme.
5. The investment income and realised capital gains in the fund would accrue with income and capital gains tax relief.
6. The pension age would be flexible and not necessarily linked to actual retirement.
In other words, an individual could draw the pension without actually having retired. However, the individual would be warned about the dangers of retiring too early and drawing a pension before the normal retirement age would ordinarily be restricted to those who had built up sufficiently large pension funds to provide an
adequate standard of living in retirement.
7. Individuals would be required to have converted a mandatory component of their pension into an annuity at retirement. Individuals would be permitted to purchase a deferred annuity before retirement. The mandatory component of the pension would be fully linked to retail price inflation. The pension would be taxable.
8. Part of the pension entitlement (up to a specified limit) could be taken as a lump sum. The lump sum would be taxable.
9. Pension schemes would operate according to a standardised set of deeds, similar to company articles of association.
10. The scheme would be administered by an independent pension scheme administrator, independent of any employers and the investment manager of the fund. This would be necessary to ensure safe custody of the scheme assets.
11. Pension schemes would have an auditor and would be required to submit annual audits.
12. The scheme administrator would ordinarily seek advice from professionals (such as economists, actuaries and pension consultants) on the adequacy of contributions. This is necessary to ensure tax neutrality over the life cycle
13. Pension fund management groups would operate on a similar basis to unit trusts as in
the UK (or mutual funds in the USA). They would collect, pool, and invest contributions on behalf of individuals. In return, the individual would be allocated accumulation units whose transfer values (calculated on the basis of single pricing) are published on a daily basis.
14. Charges must be kept low and not be frontloaded.4 There should not be a high initial fixed costs that in effect ties an individual to a particular (and possibly inefficient or uncompetitive) organisation providing particular services such as fund management. To this end, pension fund managers should be encouraged to
invest in passive index funds with a consequent reduction in costs or to accept performance-related fees.
15. Pension-scheme members would be provided with full and regular information about their schemes in precisely the same way that shareholders receive information about their companies. The information would cover:
· the status of employee and employer contributions into the scheme;
· the value and type of assets in the pension fund;
· the rates of return generated on the assets;
· the fees or commissions charged by the scheme administrator and pension
fund manager.
· an estimate of the weekly pension that the current value of the assets can
be expected to buy at normal retirement age.
Summary information on scheme structure and performance would be made
publicly available.
16. The pension industry would be supervised by a pensions regulator who would also operate a compensation scheme to compensate scheme members in the event of fraud or malpractice. The compensation scheme would be financed by a levy on all pension schemes. The regulator should also be responsible for implementing a one-stop dispute-resolution system for all privately organised pension schemes (as recently suggested by the (Office of Fair Trading 1997)).
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