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Posted On: Mar. 9, 1997 12:00 AM CST

LONDON-Business and pensions groups widely welcome U.K. proposals to privatize the state pension system, though employers are concerned about the extra costs they may face.

In a surprise move last Wednesday, Prime Minister John Major disclosed that anyone beginning work once the proposals become law will not receive a state pension but instead will have to take out a personal pension.

However, the state will adjust private pension contributions for the lower-paid to ensure they receive at least the equivalent of the basic state pension entitlement.

The proposals will not affect those currently working. On retirement they will continue to be paid a basic state pension as well as payments from the existing state earnings-related pension schemes, or SERPS.

The proposals are aimed at enabling the state, over a generation, to switch the financing of state pensions to savings and investment, funded from reductions in national insurance contributions, rather than higher taxes. It will cut public spending by about (British pounds) 40 billion ($64.57 billion) a year.

Social Security Secretary Peter Lilley said the average person should be able to build up a fund of (British pounds) 130,000 ($209,859), enough to provide a weekly pension of (British pounds) 175 ($282.50) at present prices, compared with the current single person's weekly pension of (British pounds) 61.15 ($98.72) and a married couple's (British pounds) 97.75 ($157.80).

Under the proposals, new entrants to the workforce would receive a rebate of around (British pounds) 9 a week on their National Insurance contributions which would have to be invested in their own pension fund.

While they would not be entitled to SERPS, they would receive a 5% rebate on earnings to finance a second tier earnings-related pension. While the proposed changes will present extra business opportunities for private pensions providers, they are likely to cost employers in terms of the extra administrative work involved. For existing employees, pension contributions will remain tax-free and pensions will be taxed, while for new employees, contributions will be taxed income, but pensions will not.

A spokeswoman for the National Assn. of Pension Funds said operating two fundamentally different tax regimes simultaneously will be administratively complex and costly for employers.

Secondly, she said, the (British pounds) 9 ($14.50) a week rebates the government will give each new employee in order to ensure a personal pension paying at least as much as the basic state pension are likely to have to go into a separate plan. For employers offering a final salary pension plan, this means they will have to operate the two alongside each other. This too will be "more costly and extremely complex" for employers, she added.

NAPF Chairman Tim Ross, while otherwise welcoming the proposals, said they need to give more encouragement to employers to set up company pension plans, which are "already a proven vehicle for funded second-tier pension arrangements," and that employees should be required to join these plans.

Mark Boleat, director general of the Assn. of British Insurers, said in a statement that while the proposals appear to have "considerable merit," they leave many important issues unresolved. He, too, was worried about the "administrative complexity" and the tax implications. The ABI said many important questions remain, including whether the government would promise not to tax benefits on retirement in the future. Taxing contributions might also reduce incentives to save money via a pension fund, Mr. Boleat warned.

The Institute of Directors, which represents more than 45,000 senior company directors and recently recommended a system of compulsory pensions, hailed the proposals as "a step in the right direction."

Tim Melville-Ross, IOD director general, said he welcomed the relatively low contribution level, the system of rebates and help for low earners. He added that proposals along these lines are needed, given an aging U.K. population and the need to control state social security spending.

The U.K. employers' group, the Confederation of British Industry, is expected to complete a review of the pension provision this fall. However, it said, "There is a strong prima facie case that some sort of compulsory defined contribution scheme will be part of the solution."

The government has been accused by opposition politicians of lifting elements of its proposals from the Labour Party, which has proposed shifting some of the state pension role to the private sector.

However, Mr. Major said the measures are aimed at averting a crisis in the middle of the next century, when there will be too few people working to fund state pensions for the growing number of retirees.

The Conservative government has been trying for more than a decade to reduce the state's role in providing pensions. In 1986, it gave employees the right to opt out of SERPS by allowing equivalent contributions to go instead into their personal pensions.

The latest proposals cannot be passed until after the spring general election. If Mr. Major's Conservative Party retains power, it will issue a discussion paper allowing all interested parties to comment on the proposals.

Reforms along similar lines have already taken place or are planned in Chile, Mexico and a number of other Latin American countries.