Reformed pensions can provide an alternative to the payday lenders
For millions of households, the most significant risk to financial security lies in their lack of any form of a short-term cash account on which they can draw in the event of an emergency. The consequence of this lack of reserves, for some, is that a financial shock (a suddenly disrupted income, or an unexpected bill), leaves payday lenders as the only solution.
While these companies have filled an obvious market need in making short-term credit available in times of difficulty, they aren’t cheap, and there may be a better answer.
Millions of new savers are currently being auto-enrolled into workplace pensions, as part of a scheme that began in 2012 and is due to end in 2018. The pivotal policy here is that while many of these people recognise the importance of saving for their retirement, left to their own devices they were never going to get around to it. Put them in a pension by default, however, and most of them have chosen to stay in.
This same principle of inertia can be used to help people to build an emergency cash account. We propose that the existing auto-enrolment pension system could be modified in order to give members the option to divert a small portion of their long-term retirement investments into a short-term cash account.
Pension scheme members wouldn’t even have to use their own money to build this cash account. They could opt for either their employer’s contributions or the government’s tax relief to be channelled into it for the first two or three years of the scheme. Their own pension contributions could then continue to build up a long-term pot for their retirement.
Of course, there are some clear challenges to this idea. One of the main ones is to make sure it doesn’t just become a hole in the pensions bucket, leaking money out of the system to no particular benefit. This means access to the cash accounts would have to be controlled. But at the same time, access needs to be reasonably quick in order for the idea to be effective. If money is needed in a hurry, and the pension pot can’t respond quickly enough, individuals will likely just go elsewhere.
Perhaps one solution would be to require anyone wanting to withdraw money from the cash account to have a telephone interview with the Money Advice Service first. Similarly, it would make sense to stipulate that once the cash account has been drawn down, it isn’t then available to build up to a new cash reserve for a minimum number of months or years. This would help to ensure that it remained a genuine emergency reserve account, rather than an easy pool of funds to be accessed periodically.
Some in the pensions industry will argue that this is yet more bureaucracy to deal with. This is true, and there are clearly a number of details and potential issues that would need to be ironed out before the idea is ready to be implemented. But it’s crucial to remember that this is an opportunity to pioneer a potentially important new policy which would benefit sections of society the investment industry has struggled to serve well in the past.