BBC website published Ros’s views on reform of occupational pensions
by Dr. Ros Altmann
(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)
The UK’s workplace pension system used to be amongst the best in the world, but no longer.
A former government pension adviser explains what has gone wrong and what can be done to restore the fortunes of workplace pensions.
No doubt about it, we have a crisis in pension provision in this country. The situation has been rapidly deteriorating in the past few years and we are storing up enormous problems for the future.
Why are we in this mess and what can be done?
Let’s go back to basics for a moment and just think about what pensions are for.
Pensions have two principal functions.
Firstly, pensions can provide social insurance. This was the original idea of pensions, which were designed to ensure that people who were genuinely unable to work any more when they became old, would not be left begging in the streets.
Secondly, pensions can be a savings vehicle, which allows people to invest money while they are working, in order to provide them with more money to live on when they are older.
The problem is these two aspects of pension provision have become confused.
Normally, social insurance would be provided by the state, whereas investment and savings would be the preserve of the private sector. However, ever since the 1970s the state has been passing the costs of the social insurance aspect of pensions onto the private sector, especially final salary pension schemes.
Employers have been required to provide spouse cover, revaluation of pensions for early-leavers and inflation linking, all of which are more like social welfare benefits.
seemed able to cope with shouldering the social burden. In the 1980s and 1990s many pension funds were in fact in surplus and this allowed firms to offer generous early retirement packages to workers they needed to shed.
What’s more, some schemes which were told by their actuaries that they were in surplus, decided to increase pension benefits to workers, fearing if they did not then theses surpluses would be subject to tax.
Today, the workplace pension landscape could not be more different.
Investment returns were squeezed by falls in share prices, inflation and interest rates.
At the same time, life expectancy forecasts rose. As a result, scheme finances moved from surplus into deficit.
Employers have to make up these deficits, but the costs of doing so have often become cripplingly high (often well over 25% of each members’ salary). Nowadays, finance directors view pensions as a company ‘cost’, rather than a company ‘benefit’
It is no surprise that firms have been closing their final salary pension schemes to new members or shutting them all together.
Under a final salary arrangement, the amount the worker gets depends on how long they spend working for their employer and how much they were earning at the time they gave up work.
The employer promises to pay this pension for the rest of the member’s life, however long he or she lives.
This is a huge open-ended commitment and has proved far more expensive than employers ever imagined. In truth, final salary schemes are unaffordable for most companies.
Final salary schemes are a bit of an anachronism
It grew up many decades ago, when lifelong employment was commonplace, with workers joining a company straight from school and staying with the employer until retirement. This is no longer the case. Average job tenure is only about 5 years and workers will draw their pensions for 20 or even 30 years.
No wonder, therefore, that final salary schemes are being replaced with money purchase arrangements. After all, under a money purchase scheme there is no guarantee offered by the employer that a pension fund will pay out a set amount on retirement.
The investment performance risk of the pension is borne by the employee, not the employer.
Low paid problem
One of the large problems facing occupational and personal pensions is that many low paid workers may well be better off not contributing.
This is because of the interaction between the state pension system and occupational and personal pensions.
In 2003, the government introduced the pension credit, a means-tested top up to try to lift most pensioners out of poverty. In future, about three quarters of pensioners will be eligible.
The pension credit means-test penalises any occupational or personal pensions that people have. They lose at least 40% of their pension when they claim pension credit, which means that they would probably have been better off not saving in a pension at all.
Consequently, financial advisers are no longer happy to advise smaller and medium sized companies, particularly those with many lower paid workers, on their occupational pension arrangements. In addition, many pension providers are also pulling out of this sector of the market, because of fears of later claims for mis-selling, if members end up losing their pensions when they retire and have to claim pension credit. This situation is surely unsustainable.
A radical overhaul is needed of the state pension system. Pension credit needs to be abolished and replaced with a single flat rate state pension of around £110 a week.
This will allow the state to take care of social welfare while freeing up the private sector to provide a savings vehicle on top of this, for those who can afford to save, or whose employers can do so for them.
The government should also ease the regulatory and financial burden on employers of providing a pension for their workers.
In addition, employees have to understand that they may have to work longer. Paying huge proportion of the population not to work, when they would actually be far better off staying employed, is a dreadful waste of resources and will result in poverty and long-term economic decline.
Increasing pension contributions will not provide the answer for most people, because they would simply have to save too much. Pensions alone cannot solve the pensions crisis – we must also re-think our idea of retirement. Retirement should be a ‘process’ rather than an ‘event’. We are living longer, healthier lives and heavy manual labour is not the norm in the workplace now, so most people could stay in employment well beyond age 60 in future. However, people will not need to work full-time at older ages. They should be able to work part-time, job sharing, mentoring, retraining for new types of work later in life.
These reforms could start to put pensions on a more sustainable path in future.