Let’s rip it up and start again’ – Critique of Government’s White Paper reforms
by Dr. Ros Altmann
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PENSION REFORM – dangerous mix
The recent pensions White Paper has been hailed – by the Government – as the biggest reform since Beveridge. The Government claims that its proposals will encourage a new retirement savings culture in which people will take personal responsibility for their pensions and will result in a pension system that is ‘coherent, comprehensive and will stand the test of time’. These aims are laudable but will not be achieved. In fact, the White Paper could make things worse. Far more radical changes are needed.
In essence, we have a pension system in which the state pension undermines private provision. Until the state pension is radically reformed, none of the reforms for private pensions are safe. The state pension is far too low and needs to be raised to a decent level for all pensioners, as a solid base on which private savings or other sources of income can be safely built. At the moment, neither state nor private pensions are set on a sustainable footing.
We have just about the lowest and most complex state pension in the developed world. The Basic State Pension (BSP) and earnings-related state second pension (S2P) do not provide enough income to lift most pensioners out of poverty, so Government introduced the pension credit to help poorer pensioners. However, anyone claiming pension credit loses at least 40% of their private pension income and many lose all of it. This has left a substantial proportion of the pensioner population being penalized for privately saving in a pension. Furthermore, there are still well over a million pensioners in poverty, due to imperfect take-up of pension credit.
As mass-means-testing discourages the private savings needed to top up very low state pensions, our whole pension system has become unstable.
The White Paper proposals will not solve the problems:
If the White Paper reforms are introduced, we will still have the most complex pension system in the world and far too low a state pension. The Government seems to be determined to keep the complexity of the system, perhaps as a means of ensuring it can retain flexibility over policy and introduce future cuts in state pensions, without the public actually realizing what is happening! This is certainly what has been happening for many years now.
Under the proposed reforms, both BSP and S2P will remain, as will pension credit and the complexities of contracting out. Although the Government will restore the uprating of BSP in line with earnings instead of prices, making the BSP more generous, it will keep S2P tied to prices. Also, S2P will become flat-rate, rather than earnings-related, making it less generous for many people. In fact, although the BSP will increase, so will the age from which it can be drawn, thus reducing the generosity of the whole package and also discriminating against groups with lower life expectancy.
The Government says its aim is to increase state pension income to the equivalent of £135 a week in today’s terms by 2050 (30% of median earnings). However, if the earnings link had been maintained since 1980, BSP would now be worth over £136.75 a week and we would not need pension credit! Thus, even by 2050, these complex reforms will only return us to where we could have been today, by just keeping BSP linked to average earnings. Not only that, but the proposed reforms will not help pensioners immediately and the state pension will continue to be cut, before any improvements after 2012. The BSP is currently £84.25 a week, but will fall to around £70 by 2012. Even with the reforms, around 40% of pensioners would be on means testing by 2050, thus continuing to undermine private pensioner incomes.
Why ‘personal accounts’ could prove dangerous
As for private pension reform, the proposed new personal pension accounts with compulsory employer contributions of 3% of salary, a further 1% from tax relief and employees contributing at least 4% may sound a good idea. However, almost all employers offering pensions are currently contributing well over 3%, but will be tempted to cut back to this minimum level, thus dumbing-down employer pension provision for those currently in pension schemes.
Also, these personal pension accounts may not actually be ‘suitable investments’ for people with low incomes (or high debts) because of continued mass means-testing in future. However, the emphasis on low costs precludes any advice, so people could be auto-enrolled into a product they should not be buying, and may not realize this until it is too late. Of course, because these are pensions, people cannot get their money out again and will just have to suffer any penalties of means-testing. The Government believes these problems will be minimized because the employer is contributing too. However, employer contributions are not ‘free money’ – they are still part of the wage package. If their pensions are eventually penalised by 40% or 100% when they qualify for the Pension Credit, many people will be better advised to opt out, but no-one will tell them so. Is this another huge mis-selling scandal waiting to happen? Will someone be suing the Government in future for not warning them of the risks they were facing when contributing to this official pension scheme?
So what is a better solution?
A citizen’s pension at the £114 weekly pension credit level would provide a sustainable underpin to retirement income and would be both simple and fair. Then, anything on top of that must come from private sources. This would provide a clear division between what the state pays (the social welfare underpin) and what people must do themselves, either from private saving or working more. Once private income is no longer penalized by the state pension means test, financial services providers could safely 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 whatever you save won’t be penalized. Government says this is unaffordable.
Government fails its own tests:
The White Paper reforms are supposed to meet the Government’s five tests, building on the excellent work of the Pensions Commission. These tests are:
Fairness, simplicity, promoting personal responsibility, sustainability and affordability. In fact, the only one of these 5 tests which is met with the proposed reforms is affordability. The reforms will not leave us with a simple or sustainable system, it will still not be fair to women and still favours top earners, while the lack of meaningful reform of state pensions will undermine personal responsibility. The Chancellor’s insistence on ‘affordability’ is misguided.
The myth of ‘affordability’
There is more than enough money in our pension system right now, to finance a decent state pension for all pensioners, without raising taxes. We are wasting billions of pounds each year on pension-related spending which could be redeployed. For example, winter fuel allowances, free television licences and other universal pensioner giveaways are politically popular, but cost over £3bn a year. This spending is not ‘targeted’ at all – even if you spend the winter in Spain, you still get winter fuel allowance! Also, abolishing contracting-out completely would save about £10bn a year – and meaningfully simplify our pension system at the same time. Indeed, ending contracting-out for company final salary schemes should also reduce their long-term liabilities, thus actually improving their funding position. More contentiously, 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. Redeploying some of this spending could fund a decent, fair state pension, giving a sound basis upon which individuals can plan their later life finances. This may entail measures that will be unpopular with certain groups, but the money is there. However, as long as the Treasury is wedded to the concept of credits and means-testing, we are not likely to get these much-need reforms.
The bottom line is that the Government’s pension reform proposals seem more concerned with short-term political trade-offs than with ensuring sustainable, long-term changes that we urgently need. The Prime Minister wanted radical pension reform, the Chancellor did not. We have ended up with a package which is being described as radical reform, but it is not. We need a radical overhaul of our pension system, to provide a minimum state social welfare pension to prevent poverty, and leave the private sector free to provide additional income to supplement this, either from lifetime savings, employer-funded savings, or part-time earnings in later life.
The Government says a decent universal state pension, which lifts the elderly out of poverty and recognises women in their own right, would be too expensive, however, by exploding the ‘myth’ of affordability and redirecting the current pension-related spending in a more socially just fashion, we could well-afford to finance such much-needed reform immediately.