Dave Watson introduces the latest Reid Foundation report, Pension Fund Investment and the Economy, on how pension fund investment can better serve both public workers and the Scottish economy.
Pension funds need to do more for their members and the economy. That is the conclusion of a new Jimmy Reid Foundation paper on pensions that examines our pension system, where funds are invested, and the UK Government reforms.
The UK pension system is designed to provide financial support to individuals in retirement. It has three primary pillars: State Pension, occupational pensions, and personal pensions. Occupational pension schemes are increasingly Defined Contribution (DC) at the expense of higher quality Defined Benefit (DB) schemes, placing the investment risk on workers’ shoulders.
The primary challenge is ensuring an adequate retirement income. Almost a fifth of working-age private sector employees, primarily low earners and the self-employed, do not save for a pension. Those who do save, accumulate amounts that are too low for an adequate income in retirement, typically around 8% of income, when it should be nearer 15%. The state pension does not plug the gap as it is one of the lowest in Europe. Higher state pension ages were meant to reflect increased longevity. However, longevity improvements have not been as significant as predicted a decade ago. Many are unable to work until retirement age, with 35% of men and 40% of women disabled. Increasing numbers approaching retirement live in more expensive, insecure, private rented accommodation. This leads to a combination of a low standard of living in retirement and greater reliance on housing benefits.
The paper examines the options for improving pensions, including using the taxation system to incentivise saving. Speculation that the Chancellor might change the rules on pension taxation, limiting the thresholds or taxing lump sums, did not materialise, but this may not be the end of the story. We caution against tinkering with the tax treatment of the lump sum, which would potentially undermine the retirement plans of thousands of workers. Stability is vital in pension taxation, given the long-term nature of the provision. We also argue that DB schemes should be supported and included in the reforms.
The focus of the paper is on where our pension funds are currently invested and the UK Government’s planned reforms. Pension fund investment in the UK has declined sharply in recent years, making the UK an international outlier. Seventy per cent of DC scheme assets are invested in overseas equities, and pension funds account for only 2% of ownership of UK-quoted shares. The UK also has many small pension schemes, although a significant move towards consolidation has already occurred. We agree with the UK Government that consolidation has substantial benefits, including economies of scale, reduced costs and greater responsible investment opportunities. However, questions remain over the speed of change and whether a more radical solution is required. We point to one proposal for transferring pension funds into a series of regional, return-generating, not-for-profit entities that would progressively absorb the UK’s pension funds.
In a previous Reid Foundation report on devolving employment legislation, we concluded that there is little merit in devolving occupational pensions other than expanding powers over public service schemes. The Scottish Government has not yet published detailed proposals for occupational pensions in an independent Scotland.
Finally, we examine the devolved Scottish Local Government Pension Scheme, the largest pension scheme in Scotland, with 652,753 members and assets of over £65 billion, fragmented into 11 funds. We analyse where those assets are invested, with most equity investment outwith the UK. There has been a modest increase in infrastructure investment to around £9bn, mainly within the UK, and we point to ways it could be used more effectively in Scotland. Options for governance reform and consolidation were set out in the 2018 consultation. Scotland once led the way in local government pension fund investment reform. However, progress has been glacial, and we are now trailing behind the actions taken in England and Wales.
In conclusion, we argue that while the UK reforms are moving in the right direction, there are significant gaps in the proposals, and the pace of change is slow. Pension funds need to do more for their members and the economy. In Scotland, much more could be done under existing powers. The Scottish Local Government Pension Scheme could be an important driver for the Scottish economy and do more for members.
Dave Watson is the Director of the Jimmy Reid Foundation.