Reforming state pensions is affordable if existing spending is reallocated more wisely
by Dr. Ros Altmann
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The British pension model is unique and it has failed. The crisis in UK pension provision is worsening and the demise of traditional final salary pensions is throwing the inadequacy of our state pension system into stark relief. The reason Britain has just about the least generous state pension system in the industrialised world is because it has relied on employers shouldering ever-increasing responsibility for old age income support with generous final salary pension schemes.
Our system of contracting-out encouraged millions of people to swap their state pension rights for private pension promises they were led to believe were guaranteed. However, the regulatory framework to protect these privatised social welfare benefits was inadequate and the costs and risks of private pensions have proved too high to be relied on. Both employers and governments are guilty of raiding these funds, leaving many mature schemes with huge deficits, members with no pension and hampering corporate competitiveness. More appropriate investment policies can help fund these pension promises, but as lifelong employment disappears, average job tenure declines, global competitive pressures intensify and corporate ownership changes frequently, managers cannot justify continuously trying to run down the up escalator in an attempt to provide long-term welfare benefits.
As traditional pensions disappear, radical overhaul of the UK pension model is vital. However, state pensions are so complex that most people cannot predict what they will receive and have no sound basis on which to plan. The low level and coverage of state pensions forces millions into means-testing to escape poverty. But this mass means-testing discourages the private savings needed to top up a poverty-level state pension, so the whole pension system has become unstable. This will inevitably lead to long-term economic decline, as an increasing proportion of the population struggles to live on very low incomes.
The Pensions Commission highlighted the unsustainability of our current system, but shied away from the most radical reforms, such as abolishing contracting out or providing better incentives, for fear of destabilising defined benefit pensions. If these schemes are changing anyway, why allow such concerns to hold up reform?
Adair Turner, the commission’s chairman, says a decent universal state pension, which lifts the elderly out of poverty and recognises women in their own right, would be too expensive, costing an extra £7bn a year in 2010 and increasingly more thereafter. However, there are obvious sources of pension-related funding in the existing budget that could be diverted to finance such much-needed reform.
We are wasting billions of pounds which could be redeployed to provide decent basic state pensions for all. Pension tax relief costs £21bn a year – over half of which goes to top-rate taxpayers (mostly men) – and higher rate tax relief does not even go into pensions, but is a ‘cashback’ off the tax bill. Winter fuel allowances, free television licences and other universal pensioner giveaways are politically popular, but cost over £3bn a year, money which is not targeted at all. Ending contracting-out could save nearly £8bn a year and taking these rebates away from final salary schemes should also reduce long-term liabilities, thus actually improving their funding position. In the longer term, National Insurance offers another potential source of income, with the upper earnings limit cap rendering this tax extremely regressive. NI contributions take 9.2 per cent of salary from someone earning £30,000 a year, but just 3.7 per cent from someone earning £100,000 and only 1.3 per cent from someone earning £1m a year. Anyone earning £1m from property or investments pays nothing.
So, if we need to find extra money to fund a decent, fair state pension, giving a sound basis upon which individuals can plan their later life finances, there are many ways to do so. This may require slaying some sacred cows and entail measures that will be unpopular with certain groups. However, holding up reforms out of a desire to slow the demise of defined benefit pension schemes seems a great shame, because they are changing anyway.
It is time for a radical overhaul of our pension system, to provide a minimum state pension to prevent poverty, offer fairer incentives for private sector workers to save more or work longer part-time and ensure a higher standard of living in old age.