The Pensions Crisis is back in the limelight this week as Lord Turner, Chairman of the Pensions Commission, published his long-awaited review of the UK pension system.
To recap, future pensioners face three major problems:
- An ageing population means there will be fewer workers to support increasing numbers of pensioners in years to come. At present there are over three workers to fund each pensioner, by 2050 it is expected there will be just one. This means that without change the State Pension cannot remain at it's current level (15% of average earnings).
- We are living longer, hence retirement is becoming more expensive. When the idea of a fixed retirement age (age 70) was first introduced in 1908 a man's life expectancy at birth was just 50, nowadays a man aged 65 is expected to live to nearly 88.
- The decline of final salary occupational pensions is shifting pensions risk from employers to employees.
At 472 pages Turner's report is no bedtime read, but his key proposals are straightforward:
- The State Pension retirement age should rise progressively to 68 by 2050 to compensate for the anticipated increase in life expectancy.
- Increases in the State Pension should be linked to earnings, rather than prices, from 2010. (Had the Thatcher Government not removed this link in 1980, today's State Pension would be £122.25 rather than £82.05).
- The State Pension should become "as non-means tested as possible." (Means testing currently gives lower income workers a disincentive to save).
- A new National Pension Savings Scheme (NPSS) should be established by 2010. Workers will be automatically enrolled and, unless they opt out, will contribute 4% of their after tax salary with employers contributing 3% and the Government 1%. The annual management costs for the NPSS should not exceed 0.3%.
- The NPSS should offer tax relief on contributions at a unified level between basic and higher tax rates, shifting benefit away from the rich. While this is not currently practical for other pension schemes, the Government should aim towards this longer term.
While elements of Turner's proposals make sense, we believe they fall short of solving the pension crisis. Turner has failed to address the single biggest deterrent to private sector employees contributing into non-final salary pensions - the lack of reasonable certainty over what their contributions now might be worth in retirement. It is this deterrent, coupled with loss of trust in the financial services industry and lack of confidence in stockmarkets, that has led to the present crisis. Individuals without the luxury of final salary pensions are simply not saving enough towards retirement.
| "We propose the Government sponsors a Defined Income scheme." |
We propose the Government sponsors a Defined Income scheme. This would provide a predetermined level of income at a specified age for a given contribution now. For example, a female aged 45 who wants to save £1,000 with the intention of retiring at 65 could pre-buy a fixed annual income for life of approximately £250, or an index-linked income of £130. As well as providing a known future income, a further benefit of this scheme will be extremely low charges - there will be no fund management expenses or commissions payable. The Chancellor should be happy too, because this scheme is an alternative form of government borrowing it will involve no additional costs to the Exchequer.
We also believe contribution matching is likely to be more effective at attracting savers than tax relief. The existing system has already demonstrated that the tax relief carrot is failing to tempt lower and basic rate taxpayers to save into a pension.
The extent to which Turner's proposals are adopted by the Government remains to be seen. Smaller employers will object to compulsory NPSS contributions and although raising the Women's retirement age to 65 (from 2020) provides some respite for the Exchequer, moves such as restoring the State Pension link to earnings will ultimately need to be funded via higher taxes. Given politicians don't like making unpopular decisions when the positive impact is felt long after their term of office, we are not holding our breath.