A New Blueprint for Retirement and Pensions

by Dr. Ros Altmann

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This Government could go into the next election claiming to have abolished the means test for the elderly. 

We could promise to pay the MIG plus, say, 20%, to everyone over age 80, as of right.  No means test, no claim forms to complete, no hassle, just a decent pension from Government for all 80 year olds and above. 

I think this could be an extremely powerful political message. 

It is those at more advanced ages who are least able to cope with form-filling, least likely to take up the benefits to which they are entitled and most likely to have run out of any other sources of income.  The majority of voters would be able to identify with the social imperative of providing a decent standard of living for these people. 

This new system would be more affordable, very popular, seen as a truly radical change for the UK and could be tied in with other changes to demonstrate that this Government really has thought creatively and in a coherent fashion about the current problems of pensions and retirement. 

I would recommend considering this change together with another major new piece of thinking.  We could introduce a whole new 'phase of life', which simply did not exist in the past.  This would offer people a tangible benefit from developments in the 21st Century. 

There could now be 4 phases: 

- 'youth'
- 'full time work'
- the new phase of life in which people gradually withdraw from the labour force 
- and finally retirement (the last few years, when one is truly too old to work at all). 

Thanks to the advances in medicine, nutrition, healthcare and health awareness, coupled with a reduction in the amount of heavy manual and dangerous working conditions in today's workplace, most people are well able to continue working for much longer than in the past.  The traditional 'three score years and ten' is so out of date.  

Indeed, people will simply have to keep working for longer because the finances of current retirement and pension culture just don't stack up.  It is not financially sustainable for people to retire in their 50's, after paying about 30 years' worth of pension contributions and then expect to live for another 30 years or more on those contributions.  It cannot be done.  

As soon as you allow for people earning for longer, perhaps contributing to a pension for longer, supporting themselves through their own means for longer, the finances of the 'pension years' become manageable.  It is socially wasteful for people to withdraw from the labour force as young as they currently do.  I do not believe people generally want to retire in their 50's.  They are often forced to do so.  The current final salary occupational pension structure encourages them to retire, rather than continue working at a reduced pace.  Those who are able to do so then go back to work elsewhere, but many can't.  Society needs to change its methods of thinking about working in the later years of life.  If we can offer people the opportunity to work less than full time, this would be of great benefit to them and could be seen in a positive light, rather than the negative connotations that are currently attached to the 'threat' of raising the retirement age to 70 or beyond.  People do not want to have to work at full pace, under as much strain as when they were younger, but they also do not want to stop working altogether.  Working part time, job-sharing, gradually cutting down from 5 days a week to 4, to 3 and so on would be very attractive to many people.  

This is the way to solve the 'pensions crisis' of the future.  It will take a generation to re-educate people.  The key is to start building the social consensus for it now.  Employers will need to buy in to this, to perceive the benefits of retaining older workers, but allowing them to reduce their hours of work.  Unions will need to understand that current pension promises and early retirement expectations are unaffordable and that workers can benefit from staying at work longer.  They will retain the social contacts, the feelings of usefulness, the ability to contribute to society, the ability to fund their living expenses.  All these things are often lost on retirement.  Indeed, it is not healthy for people to suddenly give up work.  Some will perhaps want to do this, but most will not want to spend 30 or 40 years without working.  Society cannot afford to allow this to continue.  Such a waste of resources and a drain on public funds makes no sense whatsoever. 

Many older workers may be able to job-share (it has been done for working mothers, so why not for older workers?)  Others may be able to fulfil a mentoring role.  Some can be encouraged to re-train and change career - perhaps in a direction they have always wanted but did not have the chance to try before.  Society needs to start this debate rolling.  

Our system currently does not recognise individual differences sufficiently.  The 'official' age of retirement concept could be replaced by a band of 'flexible retirement ages', say between 60 and 80.  Those who cannot genuinely work beyond age 60 (and there are not that many of them now) can be supported on a lower level of state benefit and their own private pension (which will presumably be an impaired life type of annuity).  Others should be encouraged to start trying to work longer and accruing bigger pension entitlements, but gradually cutting down the length of time they spend at work.  Government is already putting in place the NewDeal50+, to try to help older people find work.  This scheme could be vastly extended to cater for this new phase of life. 

We have about 20 years before the worst of the pensions crisis hits Europe.  This would be sufficient time to re-shape social attitudes and expectations.  We can plan for it sensibly now, or it can be forced upon us in the future, with the risk of panic reactions.  Surely it is better to start the debate and allow the social consensus to develop. 

There are other benefits of this new way of thinking about retirement and pensions. 

1.  Private pension provision would be less discouraged, because people would need to build up less private funding as they would stay in work longer: 

People would be able to draw a very generous state pension at age 80, but they could live on private pensions before this.  There could be a combination of private pension provision and earnings from part time employment, as the means of support before the 80 year olds can claim from the State.  Before this age, support would be less generous and subject to a means test, in order to try to encourage people to still build up their own private level of savings. 

2.       Annuities could become much better value. 

From the point of view of private support for old age, the concept of an annuity which must be bought with one's pension savings would only need to last until people are aged 80.  This immediately caps the liability which insurance companies need to underwrite and makes the economics of providing annuities much more attractive.  If people buy a 10 or 15 year annuity, rather than an unlimited lifetime annuity, the costs are more affordable and the income can be higher. 

3.       Annuity providers can buy matching assets to back annuities. 

A 10 or 15 year annuity can be matched with bonds quite easily.  An unlimited lifetime annuity, however, is impossible to match, which means providers of annuities are taking on a large risk in terms of increasing longevity and the rollover of matching assets to back annuity liabilities.

DB pension schemes are not safe.  

A DB scheme is only as good as the employer who provides it. 

Governments have not put in place any protection whatsoever to actually guarantee any level of pension to active scheme members.  Only those who have already retired are really protected.  Their rights have to be met first, plus any increases.  Then deferred pensioners.  Workers who are still contributing may not even get their contributions back!  This fact is not yet appreciated by policymakers and is not reflected in the Pickering or Sandler reviews.  Even after Maxwell, the 1995 Pensions Act, the Myners Review and all other recent debates and Reviews of pensions, this fundamental flaw in the design of DB has not been focused on.  

Current legislation allows employers to renege on their pension promises at will.  Employers are not allowed to cut workers' wages for doing the same job, but the 'deferred pay' arrangements of pensions can be cut at will.  An employer running a DB scheme can simply walk away from his obligations and wind up the scheme.  Worse than this, the Directors can and have, in some cases, retire early before winding up the scheme, to ensure that they get their huge pensions paid in full, whereas the workers may get nothing!  

No insurance is in place to ensure that people can get anything back from the scheme.  If the assets of the scheme are insufficient, workers may get no pension at all, even after contributing for 30 years!  The MFR guarantees nothing.  Even if fully funded on the MFR, this will only buy 70% of expected pensions for the workforce.  And MFR valuations are only done every 3 years.  If markets tumble during that time, the value of assets in the fund could fall dramatically and there are no safeguards to ensure that the level of pensions covered must be protected.  

The new Myners 'transparency statement' provides even less security for DB scheme members.  If the assumptions used are wrong, the asset allocation could result in significant losses for the fund and mean that people are still not provided with any certainty of a level of pension they will receive. 

When schemes wind up, it can take many months for pensions to be paid out.  The members of a DB scheme in wind up face two major uncertainties.  They do not know how much pension they will receive, nor do they know when they will receive it! 

DB has been structured in a manner which is much more protective of employers than the workforce.  Pensioners are protected to a large degree, but those not yet retired are not.  Even if they are aged 64, they may not get any pension at all.  Some kind of insurance protection must, surely, be considered.  Alternatively, a DC scheme may be preferable for many people.  

DC pensions must be the provision of the future.  They can accommodate more modern working practices easily, can provide some form of guaranteed pension, can be transferred easily from job to job and are readily identifiable as belonging to the individual.  They are not at the mercy of the employer, they are more transparent than DB, more accountable and more flexible.  DB is old fashioned, unsafe and unreliable.  Let's focus on getting DC right!

Pension credit is a major disincentive to pension provision 

Pension credit was introduced in a hurry, as a means of addressing the '75p' pension increase problem.  It is very helpful for today's pensioners, but it has the major problem of disincentivising pension saving among the very groups which Government has been trying to encourage to put money into pensions!  The policy is not sustainable and will have to be abandoned sooner or later.  Why not come clean and say so. 

Currently, pension credit is supposed to ensure that 'it always pays to save'.  This is simply not true.  For someone with less than full entitlement to the Basic State Pension, they will still lose the first part of their pension entirely, even with pension credit!  The policy was supposed to ensure an end to the disincentive effect of 100% marginal tax rates.  It does not. 

Even for those who are not taxed at 100%, the marginal tax rate is 40%.  This makes it still inadvisable for many people to put money into a pension.  Pensions are currently not suitable for a large proportion of the population.  Pension credit policy means that people have to amass savings of about £80,000, in order to be sure of escaping the 40% tax zone in retirement.  Most people cannot be confident of being able to do this and would, therefore, be better advised to save in a different form (such as an ISA) or not to save at all!  Just offering these people a simple pension and no advice will mean that Government will be guilty of mis-selling pensions to millions of people.  Unsuitable products are still unsuitable, irrespective of whether they are cheap and simple. 

So what can we do? 

Either we must make pension credit temporary.  

Or we must exempt a certain part of pension from the pension credit calculation.  

Or we must allow people to undo the pension when they retire, pay back the tax and take the MIG instead if they wish. 

Another possibility may be to offer much more generous incentives to people to put money into the pension in the first place.  A £ for £ matching scheme would make the 40% tax rate involved in the pension credit less obviously unfair.  At the moment, basic rate tax payers get only 22% top up from Government and, therefore, the marginal tax rate of 40% makes the economics unattractive.

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