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Britain’s financial crisis appears to be receding, its economic crisis is still in full swing and its fiscal crisis, with the need to reduce sky-high government borrowing, is just around the corner. But the one constant is its pensions crisis, which has been getting worse every year regardless of economic booms, and risks being with us long after the memory of today’s bust has faded.
At the heart of the problem is something that, in most respects, is a wonderful development: we are all living longer lives. Life expectancy is projected by government actuaries to increase to 86 for men and 89 for women over the next 50 years, and some estimates put the increases even greater than that.
This means that, while there are currently four people of working age to support every person over 65, in 50 years time there may only be two.
This presents challenges both for individuals and for many pension schemes. People saving for old age will need to fund more years in retirement from the same number of years of work, while certain types of pension schemes (those where contributions from today’s employees pay for today’s pensioners) will need to pay for more retirees from a smaller pool of workers.
Anyone whose retirement income has been hit by Gordon Brown’s tax raid on pension fund dividends will know that demography is not the only factor affecting pension provision, but it is certainly the main issue. And it has already led to big changes in retirement prospects.
For state pensions, the retirement age is increasing from 65 to 68 by 2046, and people are being encouraged to retire even later than that in return for a higher weekly pension.
In the private sector, companies are paying more than ever to keep their final salary pension schemes solvent, but these arrangements are fast disappearing for new employees as firms realise that it is impossible to pay for retirements, now lasting 20 years, on the same terms as before.
Final salary pension membership in the private sector has already fallen 40 per cent since 2000, and the recession will only intensify this trend, as pension funds perform poorly and companies no longer have the cash to keep schemes going. If private sector employees have pensions at all, they are now more likely to be riskier “defined contribution” arrangements, where retirement income will depend on investment performance.
The public sector, however, stands out like a sore thumb. Most public sector employees still retire at 60 on generous final salary pensions. While new employees will have to retire at 65, by the time they reach retirement the state pension age will be 68.
The scale of the divide between the fifth of employees who work for the government and the rest is now staggering. Nine out of ten public sector employees are members of final salary schemes, compared with just one in ten in the private sector.
This pensions divide costs taxpayers serious money. In addition to employer (taxpayer) contributions worth around 14 per cent of salary, the Treasury has to find an extra £4 billion or so each year to ensure that payments to retirees are met. And with the unfunded liabilities of public sector schemes exceeding £1 trillion on some estimates, these annual payouts will only get bigger.
Two arguments are often put forward to defend the pensions divide: firstly, that generous pensions are a fair reward for a lifetime of moderately paid public service, and secondly, that just because the private sector has cut back on pension provision doesn’t mean the public sector should do the same.
But these arguments no longer hold water. Pay in the public sector is now higher than in the private sector at all but the highest levels, and the enormous sums the government is currently borrowing mean that serious efforts will soon have to be made to reduce public expenditure, including the pensions of state employees. It is surely unfair for taxpayers to pay dearly for pensions that they cannot afford for themselves.
There is no doubt that people will have to retire later and probably bear greater risks to their income in old age, but retirement provision in the future need not be all doom and gloom. Opportunities for older workers are increasing steadily, as more and more people over 65 opt to stay in at least part-time work. And at the same time, a number of problems that beset our pensions system, including the lack of incentives to save, could be overcome by serious reform.
The choices are not easy, but a state pension age and public sector retirement age of 70 would free up enough money to increase greatly the basic state pension. In fact, it could be increased up to or beyond the current means-tested pension credit guarantee level.
This means that means-testing in retirement could be completely abolished, without any more resources needed from taxpayers. And once again, it would make financial sense for people on lower incomes to save, with every £1 they saved making them at least £1 better off in retirement.
The pensions crisis is real and it is serious. But the pension system is not beyond help.
I absolutely agree with the premise of this article. It seems absurd that the public sector can continue to benefit from such costly pension provisions.
I also think it untenable that MPs can continue to benefit from a pension system which the majority of people they govern can no longer benefit from. As a point of principle, the interests of those in government should be aligned with those of the majority of people they govern. At present (in relation to pensions) there is a parallel between MPs and the much maligned bankers in that their pensions (or bonuses in the case of bankers) are protected regardless of long term economic performance.
This needs to be addressed, but how likely are the turkeys likely to vote for Christmas?
Inevitably we are going to have to face longer working lives and I notice that Denmark has already increased retirement age to nearly life expectancy.
How are we to find meaningful employement for millions of people when the long term drift in the West is towards highly knowledge intensive businesses moving and adapting fast to changing landscapes.
The last 20 years has seen a concentration of the rewards of success in the hands of fewer and fewer people ie less and less people have truly valuable jobs.
I think we will have to re-evaluate the meaning of employment and allocate value to tasks such as caring and teaching so that more people can be valued and rewarded for their true contribution.
The question is can the few be persuaded to share their treasure?
I am deeply saddened by the impact that government policy has had on pensions in the private sector. Having said that, with life expectancy increasing it is absolutely necessary to have a pension policy that we can afford as a country. Hence I agree that it is necesary to futher increase the retirement age. I am equally convinced that the public and private sector should be brought into line.
Perhaps you would also like to comment on two further suggestions:
1. State pensions be regarded as a safety net rather than a universal privilege, ie those close to or above the Life Time Amount should not receive a State pension. My occupational pension discounts my State pension when (and if) I receive it, so it is of no net benefit to me.
2. The unfunded public sector and State pensions become funded schemes, with all of the limitations on pay-outs that that implies. How conveniently we ignore the biggest Ponzi scheme of them all, simply because it is government-run.
IAB
Gordon Brown is DUPLICIOUS, worse than Blair who lied about the Iraq war.
Yet people still vote for Labour. Maybe it is beause they have encouraged so many people to live off the state on benefit without being responsible themselves for their own lives.There needs to be a restoration of responsibility and values. Brown and Blair were morally bankrupt as politicians. Brown was a disasterous chancellor.He became prime minister unelected by all voters.He has now made the U.K.totally bankrupt.What a legacy! We are still in recession despite his reassurances.Brown also promised the electorate a referendum on Lisbon at the last election.He has let down that electorate by breaking his electoral promises. He deserves to lose the next election. His tenure as PM is best summed up in one word – DUPLICIOUS. This was originally expressed by the Americans so I am not alone.
The solution to pension funding is a long-term one. If everybody, including state workers, starting work today was made to invest 10% of income into a private pension scheme,we could overcome the pensions problem by 2055
This eventual short-fall in the Government’s ability to provide adequate pensions has been well documented over many years.We are an ever increasing ‘aged’ population being supported by an ever decreasing working population. This is a fact of reality.
To ease the Government’s burden of having to provide pensions at an expectancy rate equitable with a faster growing cost of living, they could decide to effect the following proposal:
1. Continue with tax relief on contributions to a company/personal pension fund as an incentive to save, and,
2. Give full tax relief on either all or part of any pension payments received by pensioners.
The benefit of such a concession would result in pensioners requiring less pension to meet current cost of living and, relieve Government of having to fund it’s initial pensions pot at a rate equal to growth in cost of living standards.
Great article Corin & spot on !
The govt is sticking it’s head in the sand when it comes to public sector pensions and the longer it waits to make the innevitable tough decisions the more painful they will be.
:) Martin
The UK had excellent pension schemes with a long term security and a potential for evolution to meet changing circumstances. The “prudent chancellor” Gordon Brown crippled that in much the same manner as he has attempted to destroy the UK economy, by attempting to fund the public sector growth at the expense of the private.
I agree that the Pension Age should be raised to 70. So should the starting age for all old age benefits. And it should keep rising; the expectation should be that on average the retirement period in one’s life should be an expectation of 15 years. Ahead of that, everyone is fitter and healthier and so capable of doing something productive, which in itself makes life so much more interesting.
The Pensions Crisis is well identified in all resposnsible circles except it seems in Westminster. Our MPs appear bamboozled by the Treasury HMRC and its mega rule book on pensions. Surely it is benficial for the country to encourage long term savings and funding and to have a wealthy retired population. We do need fresh thinking due to the changes in the lifestles of the over 60s and our longevity. Putting more tax and barriers in the way is the last thing we need. Should every member of the IOD lobby their MP? Martin
I totally agree with Corin Taylor’s comments. The arguments apply to both central government employees and those in local government.
As government spending is reduced, the proportion spent on pensions is increasing.
One of the worst cases is the Metropolitan Police, where most employees retire aged 50 on maximum final salary pensions.
It will not be long before more is spent on pensioners than serving police officers – and we wonder why we are seeing fewer officers on the street.
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It would talke an act of political will of Thatcherite proportions for a Government to take on the vested interests at work here, (especially where public apathy prevails).
Perhaps the most likely driver for change will be a downgrade of UK Sovereign debt -as and when the rating agencies wake up to the extent of the problem.
Outside the public sector in the UK very few of us are in final salary based pension schemes so instead we have no choice but to accumulate a pension fund and then convert the final fund into a pension when we retire. This is very risky – especially compared to a scheme that instead provides a proportion of ones final salary as a pension. Its because the sponsor of the final salary scheme takes on these risks that makes them so costly.
For the rest of us in the UK saving for a pension now works like this:
1. Make pension contributions (if you’re lucky your company might contribute) that then get invested in some fund or funds (in order to get a decent long term return these funds invest usually in equities). BUT the future returns are uncertain, in many cases they could, potentially, be negative!
2. The whole idea is to save for a pension (i.e. an income for life starting from retirement). So the unknown final pension fund pot has to be converted into a pension at retirement. An element can be taken as cash but the majority is converted into a pension income by what are called annuity rates. The problem is annuity rates are volatile too, for instance they have fallen by 45% over the last 10 years!
Many people (me included) don’t like this double risk but if you want to save for your retirement and utilise the tax reliefs and incentives on offer you don’t have a choice. That is until now. I have just discovered a new type of personal pension, its called a defined benefit personal pension.
Don’t be put off by the name, its very simple. You still make your pension contribution (or transfer from your existing pension fund) but what you get is not linked to the stockmarket and is not subject to future annuity rates. This new type of pension plan provides you with a known, fixed and certain pension from your selected future retirement date. So in return for your contribution you get told what your future pension (from the date you choose) will be. It wont be more but it wont be less either. (By the way you can still give up some of this pension for tax free cash when you retire).
With traditional pension plans you have annuity rate risk and once you get say 5 or 10 years from retirement the volatility of the stockmarket becomes a real problem. But with the new type of plan you also have to weigh up the ‘price’ you pay when buying something that is guaranteed. Obviously investing in the stockmarket offers maximum potential final pension fund value but dont forget you’re trying to maximise your pension and NOT your pension fund (e.g a ‘large’ pension fund at retirement multiplied by a ‘low’ annuity rate doesn’t equal a ‘good’ result).
Therefore I’d recommend a mix of stockmarket based personal pensions and defined benefit personal pensions. If you are happy to take all the stockmarket and annuity rate risk (e.g you’re you have other back up) then go 100% for the former, if you don’t like any risk at all then go for 100% the latter. I guess most of us being somewhere between these two extremes, tending to move more towards the certainty of the guarantees as we get closer to retirement.