FT comment piece on pension reform

by Dr. Ros Altmann

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Pensions policy is heading in the wrong direction. It has not adapted to improvements in longevity, health and work practices over the past 50 years. Pensions are in crisis, as companies and individuals cut contributions and confidence has collapsed. This will lead to poverty and economic decline.

The UK pension model - based on offloading state pension responsibility onto the private sector - is failing. State pensions have been cut, and we have spent billions encouraging people to transfer into private pensions, because successive Governments believed private funds - invested in equities - would deliver better pensions over time. Until 2000, unusually high equity returns seemed to validate this model, but that was an illusion. Transferring pension risk away from the state does not make that risk disappear. If the private sector does not deliver, the risk ultimately falls back onto the state anyway. State pensions have been reduced too far, and private pensions have not offset this, leaving half our pensioners (and three-quarters in future) needing means-tested pension credit to avoid poverty. This undermines private pensions. Pension credit claimants lose 40% or even 100% of any private pension, so locking money into a pension just doesn't make sense for basic rate taxpayers. Compulsory contributions in this environment are surely unthinkable, since pensions are an unsuitable investment for many people.

We urgently need to change course. Scrapping State Second Pension and introducing a £110 per week citizen's pension, indexed to earnings, would simplify state pensions, ending mass means-testing and pensioner poverty. The additional £7billion a year cost could be financed, without tax increases, by the £11 billion savings from abolishing contracting-out rebates. The age at which this pension starts could be indexed to longevity. The state would no longer provide earnings-related pensions, but it is not clear why it should. If people earned more when working, why should this mean Government has to pay them more when they are not working?

A citizen's pension provides a clear division between what the state pays and what people must do themselves. Once private pensions are no longer penalised, financial services providers would be free to sell pensions to the mass market, with a clear message. Government will provide enough to live on, but only just. To have a better lifestyle later, you will need more - and your savings won't be penalised by means-testing.

We then need better pension incentives. Policy has concentrated on 'supply side' reforms -informed choice and cheaper, simpler products - but has ignored demand. People have lost faith in pensions and don't want to contribute. Current incentives rely on tax relief, costing £10billion a year, (half of which goes to top-rate taxpayers). This is inefficient, opaque and regressive - giving highest incentives to those who need least. A system of matching payments, providing the same incentive for the same contributions - perhaps £2 for every £3 contributed - would be fairer, clearer and more effective in encouraging basic rate taxpayers to save. If this were coupled with 'soft compulsion' reforms, such as requiring people to opt out of employer schemes, rather than opting in, or encouraging them to put part of any pay rises into a pension each year, evidence suggests take-up would dramatically increase.

Urgent action is needed on occupational pensions. Most final salary schemes have closed, as they have become unaffordable. Employers expected strong equity returns to meet these open-ended, inflation-linked commitments, but they did not. The uncertainty of this 'pray-as-you go' approach has left huge deficits and thousands of people destitute, despite decades of contributions, which has undermined confidence.

Contributions to new occupational money purchase schemes have fallen sharply. With average job tenure around 5 years, employers no longer feel obliged to provide pensions for their workforce and, if we want them to contribute, better incentives are required. Compelling them may have some appeal, but employer contributions have to come from somewhere. If companies put more money into pensions, then wages, investment, employment and/or profits must fall. We must recognise financial reality.

The bottom line is that pensions cannot solve the pensions crisis! Policymakers should start this debate. Most people will never be able to save enough to provide a 'decent' pension. Pensions were meant to last 5 or 10 years, but people now expect them to last for decades. Paying people not to work, when they are able to, is such a waste of resources and is unsustainable. Just raising the retirement age is not the answer. A more flexible approach, which can accommodate demographic change, is needed. Retirement should be a process, rather than an event. There is a new phase of life, waiting to be grasped. 10 or 20 years working part-time at older ages. This is much healthier for individuals and the economy. The policy challenge is to encourage employers to provide jobs and help individuals plan for gradually cutting down, rather than suddenly stopping work completely.

We must radically re-think retirement, abandoning fixed retirement ages. Pensions could then supplement income, rather than providing a complete replacement. Gradual retirement, coupled with a citizen's pension and better incentives, would finally bring pension policy into the 21st Century.

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