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A combined pot may offer better pensions for all

AS the season of pre-election magic wands gets under way, Pensions Minister Steve Webb is promising to increase state pensions by up to £25 a week and workplace pensions by 30%, at no expense to taxpayers.

So where's the catch?

The state pension top-up will be on offer, at a cost, to anyone hitting pension age before April 2016. The price (to be confirmed) could be a £900 payment for every £1 of extra inflation-linked pension per week, up to a maximum payment of £25,000. Experts say that would be a very generous deal, as £1 a week of annuity pension currently costs nearly £1500 to buy.

Hugh Nolan at JLT Employee Benefits said: "As only half of women get a full Basic State Pension (compared to 90% of men), giving them the opportunity to make up this gap on favourable terms is particularly welcome. It won't be right for everyone, as those in ill health might not expect to live long enough to get all their money back and others might prefer the flexibility of spending lump sums."

The promise to boost non-final salary workplace pensions is more intriguing.

Webb is now championing a model pioneered in Holland and also seen in Denmark, Sweden, parts of the United States and Canada, where contributions do not create individual pension pots but all go into a pooled fund. This is said to allow lower costs, more freedom of investment over longer time periods, and the ongoing payment of higher and more predictable pensions to retirees, who would not have to lock into an annuity.

According to a report by research backed by modelling from actuaries Aon Hewitt, over the past 57 years such collective defined contribution (CDC) schemes would have produced individual pensions 33% higher than those actually delivered by defined contribution schemes in the UK.

The National Association of Pension Funds and business group the CBI are both backing the idea, as is the TUC, whose general secretary Frances O'Grady said last week: "The minister should stand up to the vested interests who will attack this approach, and work with the many who want to work through the detail."

Vested or not, former Labour minister Lord John Hutton is among the interested sceptics. He says a CDC could create intergenerational unfairness, make it difficult for members to assess their exposure to risk, and fail to address individual needs.

Meanwhile, leading independent consultant John Ralfe said that a CDC could trigger "a transfer from younger current employees making contributions to older pensioner members and would become a Ponzi scheme".

He warned that schemes would need strict rules with "the ability to cut pensions in payment and even claw back pensions already paid", if solvency deteriorated due to poor investment performance or increased longevity forecasts. That has already happened with 66 schemes in Holland, critics note.

Ralfe argued that a CDC "can work only if third party investment banks or insurance companies are prepared to provide guarantees of long term equity outperformance."

He added: "Unless this happens - which it won't - CDC is a con, persuading individuals that the risk is less than it really is … it is not a magic wand to make risk disappear."

Tom McPhail, pensions expert at Hargreaves Lansdown, said: "There is clear evidence both from recent Dutch experience and from our own with-profits funds that such schemes can go down as well as up. They are complex, uncertain, unproven and rely on a constant flow of new members for their long-term sustainability."

McPhail argued instead for "a well-judged price cap on auto-enrolment schemes, reform of the regulations on the sale of annuities, and the promotion of long term investing". Hutton said that the real priority is to engage with members and "re-establish the connection between saving and retirement".

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