There is no Magic Money Tree for Pensions

At last the radical overhaul of pensions that should have happened long ago is on the table.

The Times
15 January 2013

The Government’s proposals for a flat-rate decent state pension will finally help people understand what they can expect from the State and what they need to do for themselves. It undoes many mistakes of the past, but more will need to be done, such as reviewing when people can start drawing the state pension. For far too long, politicians ducked the difficult issues that arise from increasing life expectancy. When Beveridge devised the post-war pension system, only a minority of people lived to 65. Today, more than a third of newborns are likely to live to 100. Yet, there has been hardly any change to pension ages, indeed we have seen a trend to early retirement which has fostered completely unrealistic expectations. People have been led to believe that there is some magic money tree that will provide good pensions for ever-longer retirements, even as there are fewer future taxpayers.

Previous governments have dealt with pensions in a piecemeal fashion. The original Beveridge idea of a basic state pension paid to all those who contributed for a full working life was supplemented by various earnings-related elements. Indeed, in the late 1970s, a very generous State Earnings Related Pension Scheme (Serps) was devised, that would give much higher pensions to those with higher incomes while also allowing people to opt out of this if they had a private pension arrangement. This contracting out meant many workers and employers paying lower National Insurance in recognition that the private pension scheme would pay the additional pension instead of the state.

No other country chose to have such a system of contracting out which relied on the assumption that private investments would generate sufficient returns to keep up with rising life expectancy.

Politicians seemed to believe they could rely on the magic of markets to deliver good pensions so they periodically cut state pensions expecting this to be offset by rising future private provision. This policy has failed.

In 1980, the basic state pension was tied to price rises rather than earnings. Pensioner incomes fell far behind the rest of society, which has left millions in need of extra mean-tested benefits to avoid poverty, as well as winter fuel payments and Christmas bonuses.

There is little doubt that the UK state pension system is not fit for purpose. It is by far the most complex in the world.

The full basic state pension is now only £107.45 a week, but this can be topped up to £142.70 by the pension credit, for which 40 per cent of today’s pensioners are eligible. However, this mass means-testing penalises those who have made their own private provision, especially those on moderate income. Just as we are automatically enrolling millions of workers into an employer pension scheme, it is vital that the means-testing penalties are removed.

I find it astonishing that policymakers are only just admitting the need for radical change. It is no secret that large numbers of baby-boomers are reaching retirement age — they have been alive for many decades. It is no surprise that they had fewer children, we have known that for years. It is also no surprise that life expectancy has increased hugely in past decades either. Yet pensions policy has been stuck in a time warp. At last, there is more realistic thinking.

We need to go back to the simple idea that there is one minimum payment that anyone reaching pension age will receive from the state. Ultimately, if it is set at a decent level, the contentious extra benefits, such as winter fuel payments could be rolled into it. People can then plan for their future with confidence. If they want more than the mooted £144 a week, they will have to do something for themselves. Either they will have to save more, work for longer or find money elsewhere. But we won’t have the excuse of believing in the magic money tree. The state will give you a minimum, the rest is up to you.

Dr Ros Altmann is a former government adviser on pensions policy