The British started paying National Insurance (NI) in 1946. Before that, state pensions had been available but were means-tested. The new idea was that everyone would contribute and everyone would then be entitled to, among other things, a set state pension that would provide a minimum but reasonable standard of living “below which no one should be allowed to fall”, as the scheme’s architect William Beveridge put it.
So much for that. Today the state pension is paid at such a pathetically low level that anyone living on it alone would be more destitute than secure. That isn’t going to change, mainly because the public finances won’t allow it. So to compensate, the government is working on finding ways to make us all take on financial responsibility for our own retirements (while continuing to pay NI at a rising rate of course).
The latest effort comes in the form of the National Employment Savings Trust (Nest). It will work like this: unless they specifically opt out, employees will automatically pay 4% of their salary into the scheme. Their employers will pay in another 1% at first, rising to 3% by 2017 and taxpayers will chuck in another 1% by way of tax relief.
So by the time the thing is fully rolled out (it will be launched in stages, with the biggest employers forced to participate first), employees who don’t opt out will be getting the equivalent of 8% of their salary going into their pot every year. But good as this sounds, there are problems a-plenty with the plan.
First is the simple fact that persuading people on low incomes to save might not actually be much good for them: if means-testing later means that they lose out on benefits as a result of having savings, they’ll have sacrificed part of their incomes for nothing.
The second problem is time – it is all very well getting people to save but should those with small pots be encouraged into the equity markets, particularly if their retirement looms in the next decade or so? A responsible financial adviser would probably say no.
The third problem is the usual one – cost. Much has been made of how cheap Nest will be. But for those first in, it won’t be remotely cheap. Why? Set-up costs. Nest has apparently borrowed around £600m from the government to get going. And it doesn’t intend to pay that back out of its annual fees.
Instead, it will charge a 2% levy on all contributions until the costs are covered – and it won’t make a guess as to how long that will take. Maybe ten years. Maybe 20.
So, if you sign up in 2012, you’ll be paying for the £360,000 that was spent on designing the logo (the word Nest inside an egg). You’ll be paying salaries already paid to managers who’ve been employed by the scheme for several years – the chief executive was appointed in 2007 and takes home £200,000 a year. You’ll be paying for all the bureaucracy and dilly-dallying that surrounds this kind of thing.
Then there are the fees: Nest says it is aiming for an annual management charge (AMC) of around 0.3%. That’s a nice idea. But it isn’t very likely. The scheme is forecast to have around £150bn under management by 2050 and, should that happen, it is possible that a manager would take it on at 0.3% (£450m should be about enough to cover anyone’s costs). But in the early days, when a few hundred thousand people are chucking in under £1,000 a year each? No way. One percent would be a more realistic guess.
And don’t forget that the AMC is just the beginning. Add in the rest of the expenses that come with the average fund and your total expense ratio (TER) is going to end up at more like 1.5%. All this worries experts – they think it might deter people from participating. I’m not so sure. UK investors seem remarkably relaxed about fees – if they weren’t, how would an industry that charges punters 1.5%-plus of the value of their assets to underperform (on average) any given index survive at all?
The real risk is not that we won’t invest but – in the early years at least – that we will and that we will be disappointed by our returns.
Let’s say you earn £20,000 and enrolled in Nest in 2012. You put in 4% a year (£800). Then you get another 1% back in tax (£200) and 1% from your employer (£200). You pay a 2% charge on contributions every year, alongside a TER of 1.5% and your manager makes an annual return of 6% (I’m trying to be optimistic).
By the end of 2017, your pot would be worth £6,500. That’s not bad – if you had just put your own £800 in a savings account at 5%, you’d have only £4,600. But the fact that you do better by being in Nest is not a function of the low costs we hear so much about, but of the contributions the taxpayer and your employer are forced to make. Putting £1,200 a year in a savings account at a much lower rate of return of, say, 4% would have done much better, leaving you with a pot of £6,760. That rather suggests the scheme will be feathering the wrong Nests.
• This article was first published in the Financial Times