How indy fund could offer more than just a basic state pension

The NPF can also be designed to provide earnings-related pensions to all citizens in addition to a state pension.

Discussion about the future of pensions in an independent Scotland has, so far, been limited to proposals to increase the state pension we will inherit from the UK.

While increasing the state pension would be affordable if Scotland had its own currency, it will not eliminate the demand for second pensions.

Even if the state pension was increased to £400 per week, this would still provide a retirement income of only 54% of current median earnings.

With such a drop in income at retirement for many, demand for second pensions will persist.

This means we also have to consider second pension provision after independence.

It is widely recognised that “defined benefit” (DB) or final salary pensions offer greater certainty and security than the alternative “defined contributions” (DC) type. The problem is that DB pensions have largely disappeared, particularly in the private sector. Our ambition for future pensions in Scotland should be to restore DB pensions. Creating an NPF is the only way Scotland could do this.

We cannot rely on employers to revert back to providing DB pensions. They have disappeared primarily because all employer-based schemes suffer from a fatal flaw.

Eventually, the number of pensioners exceeds the number of contributing workers and contribution income is no longer sufficient to cover the cost of pension payments.

Investment returns must make up for the shortfall and employers eventually decide they will no longer bear the investment risks.

An NPF would avoid this flaw because the worker/pensioner ratio is predictable based on national demographic trends.

This makes it possible to calculate a contribution rate sufficient for contribution income to provide the cashflow needed to pay out pensions.

The NPF can be designed as a “pay-as-you-go” scheme. If there are three workers to every pensioner and the scheme was designed to deliver a DB pension of 50% of earnings the required contribution rate would be 1/3 x 50% = 1/6 (16.7%).

Suppose the average earnings of three million workers were £30,000. Total wages = £90 billion and contributions of 1/6 = £15bn. The average pension would be £15,000 and one million pensioners would produce pension spending of £15bn; income and pension costs are equal.

The NPF would be established by introducing auto-enrolment for all new workers after a defined date.

As none of this group would draw a pension for 40 years or more, the initial contribution rate can be set at a lower level than might be necessary in 40 years’ time.

Even with an initial contribution rate of 15% the fund would grow quickly so that there would be a large fund available for investing in the Scottish economy and with capacity to meet its obligations to pensioners.

Once the NPF has been established, existing workers can be offered the opportunity to transfer their second pension(s) into the NPF. Transfers between pension funds are already common.

A transfer would be based on the cash value of existing pension(s), which then earns a credit for contributions into the NPF. Suppose a cash transfer is valued at £45,000 and the required annual contributions to the NPF based on current earnings are £4500 per year; the transfer value would earn a 10 years’ credit.

Transferring into the NPF would be attractive to those who have a DB pension as the value of their “pension pot” (the total of their contributions and investment returns) would be converted into an earnings-related pension.

In an NPF, the investment risks are pooled across the whole working population and employers.

In addition, the state, with the benefit of issuing its own currency, can guarantee the fund. The state would function as the “sponsor” of the NPF but, unlike a sponsoring employer, it cannot run out of money nor is it likely to cease trading.

The guarantee would provide additional funds to the NPF in the event that cashflow into the fund was insufficient to pay all pension obligations. It is highly unlikely that a well-designed, well-managed and fully accountable NPF would ever need to call upon this state guarantee.

It is intended that the NPF would be a provider of a DB-based second pension in addition to a state pension. The replacement of the flat-rate state pension inherited from the UK with an earnings-related state pension (SERP) would complete a new model for pension provision in Scotland.

How much of total pension comes from the SERP and the NPF would be a matter for public consultation.

Tags: