Radical proposals on pensions could lead to biggest shake-up in a decade

The simple solution for retirement income may yet prove to be costly for employees

The long-awaited review of the byzantine world of British pensions was published yesterday, causing a stir from Whitehall to the City that Alan Pickering, the cricket-loving actuarial author of the report has probably not been used to in his long career in the pensions industry.

Mr Pickering insists what he has suggested, slashing red tape and allowing companies to drop certain pension promises, is not the "nuclear option".

The nuclear option, Mr Pickering believes, is in fact a continuation of the status quo. This would lead to more and more companies scrapping valuable pension schemes, leaving many employees with only a poor understanding of their own pension needs to rely on less good pension schemes, probably leading to grossly inadequate savings for old age.

Yet by his own admission, Mr Pickering has come away from this 10-month investigation of the pension market with by far the most radical set of pension proposals to be put forward in a decade. The last was the raft of regulations rushed through in the early 1990s to try to close the regulatory loopholes that allowed Robert Maxwell to embezzle millions of pounds from the Mirror Group pension scheme.

Mr Pickering, who was commissioned by the Government's Department of Work and Pensions, said: "I want the DWP to scrap all pensions legislation on the statute books and replace it with a new kind of pension act, that would be in part Continental and in part UK in its approach."

The plan would be to get rid of the reams of complex rules that have been built up layer on layer over the past 50 years, and pass one simple Pensions Act, in 2003 or 2004, that would set out clear policy principles.

The Act would be buttressed by more detailed codes of practice, but nothing would be set out in the same detail as under the current system. To avoid another Maxwell, company pensions would also be policed by a new, more pro-active regulator which would be quicker to investigate potential abuse than the current, reactive, Occupational Pensions Regulatory Authority.

Alongside Mr Pickering's reforms, which he styled the "social policy" side of pensions, is a complete overhaul of the pension tax system by the Treasury and Inland Revenue. This review promises to reduce to just a handful the types of pension available so that more light is shed on a market which has been mainly known for its complexity.

Change on such a wide scale is called for, Mr Pickering believes, because the state of Britain's collective retirement saving is in a parlous state. Altogether, people are saving £27bn less than they should for old age and that ignores massive variations between the rich – who on the whole save a lot – and the poor, who don't.

The fundamental problem which the Government can no longer ignore, Mr Pickering pointed out, is not that employees' pension schemes might be getting worse, but that half of the population do not have any kind of private pension provision whatsoever.

The large number of regulations and the onerous rules that govern especially company pension schemes have created a "fortress mentality", Mr Pickering believes, between those with private pensions and those outside. "We have got to make sure that people outside the fortress feel welcome and to do that we have got to simplify the system," he said.

This could be done by pulling down some of the ramparts around occupational schemes to make them cheaper and easier to administer by companies, who are feeling stretched at the moment because two years of falling stock markets are making pensions guarantees to staff particularly onerous.

One rule Mr Pickering suggests could be removed is the obligation that companies pay a pension to the widow or dependant of a deceased pension scheme member. Companies should also no longer be forced to link the pensions they are paying out to a rise in prices.

The suggestions drew an outcry from charities and trade unions, which insisted that both changes would create more poverty among pensioners.

This erosion of rights for people within company schemes is the price Mr Pickering says we ought to be prepared to pay in the hope that lightening the burden on companies will persuade them not to close their coveted final salary or good-quality money purchase pension schemes altogether.

Mr Pickering – whose background is in the pension industry, and does not have particularly close links with Government – has voiced the view of many senior figures in the pensions industry.

Colin Singer, a partner at the same firm as Mr Pickering, Watson Wyatt, said: "It may be politically incorrect to say it, but the balance between the employer and employees in the pension scheme has been skewed too far towards employees, which has meant a number of schemes closing defined benefit schemes. This won't be stopped until more control returns to the employer."

Pension companies broadly welcomed Mr Pickering's proposals. Jerry Barnfield, director of pensions at Norwich Union, said: "Do you offer your staff a Rolls-Royce scheme, or a Ford Mondeo or nothing at all? If you cannot afford the Rolls-Royce, surely it is better to have the Ford Mondeo."

Unsurprisingly, the pensions industry does not just want Mr Pickering's changes. It is pinning its hopes on the Treasury tax review as a way to get people to save more.

Michael Leahy, marketing director at Standard Life, said: "Mr Pickering's proposals only tackle half of the rules. This could be as simple as having a regular savings product, including occupational and private pensions, a stakeholder and a self-invested pension that would so simple anyone could understand them."

Richard Astle, director of corporate affairs at the financial services group AMP, said: "We have got to do something demand-led. That could be much more tangible tax incentives, such as the Government matching the individual's contribution."

Mr Pickering's proposals left the Government clearly uncomfortable. Andrew Smith, the Secretary of State for Work and Pensions, said he would consider how to use Mr Pickering's proposals, but added that at first sight, the ideas "are not attractive."

Mr Pickering did not suggest compulsory pension contributions, but he made it clear this might be the next step, saying: "This gives the Government one last chance to see whether voluntarism will work."

The Government knows that difficult decisions have to be made about pensions if it is to even vaguely meet its target of ensuring that 60 per cent of pension provision is funded by individuals and 40 per cent by the state by 2050 – the exact opposite of the situation now.

The Pickering Report: Your questions answered

Yet another Government-inspired report about savings and investment ­ what is this one about?

The Department of Work and Pensions asked Alan Pickering, former chairman of the National Association of Pension Funds, to make Britain's bewildering pensions market simpler so that people would start saving more for their retirement. He has approached the Herculean task by focusing on improving occupational schemes.

I am a member of my company scheme. Will Mr Pickering's proposals affect me?

Quite likely. Any changes that are brought in will not affect the money already paid in by you or your employer. But your company could decide to change the rules for any money you put in from now on. On new contributions, your company could scrap its promise to raise your pension in line with prices once you are retired. Or it could remove its guarantee to transfer your pension onto a spouse or dependent. However, your company will not be forced to make any of these changes. Many observers believe that especially large employers will retain these extra benefits as a pull for good staff.

But I thought defined benefit (DB) schemes were meant to be the gold standard of pensions precisely because companies can't tamper with them and because you get a guaranteed amount when you retire. Could they be changed by the Pickering report?

Yes. As seen recently, a number of companies closed their DB schemes to new contributions. The contract protects money already paid in but not new money. Both DB, also known as final salary, and money purchase, also known as defined contribution, schemes could be affected by Mr Pickering's proposals.

I have no pensions savings at the moment. Will the proposals help me?

Undoubtedly. Mr Pickering wants to make it easier for the young and those on modest incomes to save. He is proposing money that is put into a company pension scheme should start building up immediately so that if individuals move to other jobs they can take those contributions with them. At the moment, employees can work somewhere for up to two years and still forfeit all the contributions their employers have made if they change job within that time. Mr Pickering's suggestion that companies could force new recruits to join the scheme could also be beneficial because employers would only be allowed to do this if they were offered quite generous additional contributions.

Will these changes really encourage us to save more for retirement or will the Government have to bring in more fundamental change?

Mr Pickering thinks his proposals are anything but unambitious, but the Government does also have its own big plans. The Treasury and Inland Revenue are putting together plans to transform the tax regime surrounding pensions. This might not mean more tax breaks overall, but it will mean much simpler rules. If tax incentives don't work, all that is left is making pension contributions compulsory. Mr Pickering said it should be avoided if at all possible and the Government has so far eschewed the idea, but it may be brought out if reforms suggested by Mr Pickering and earlier this week by Ron Sandler do not work.

Mr Pickering was asked to make things simpler. Why not just give people complete freedom of choice and allow people to opt out of pensions altogether?

This isn't going to happen. Mr Pickering said he believes the basic structure of pensions, which is based on guaranteeing an income in retirement for as long as you live, is the way to fund old age and the Government agrees. The system of paying contributions over a number of years and buying an annuity with most of the accrued amount is here for the long term. So you might as well work out how best to use it.