FT comment
piece on pension reform

by Dr. Ros Altmann

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Pensions policy
is heading in the wrong direction. It has not adapted to
improvements in longevity, health and work practices over the past
50 years. Pensions are in crisis, as companies and individuals cut
contributions and confidence has collapsed. This will lead to
poverty and economic decline.

The UK pension model – based on offloading state pension
responsibility onto the private sector – is failing. State pensions
have been cut, and we have spent billions encouraging people to
transfer into private pensions, because successive Governments
believed private funds – invested in equities – would deliver better
pensions over time. Until 2000, unusually high equity returns seemed
to validate this model, but that was an illusion. Transferring
pension risk away from the state does not make that risk disappear.
If the private sector does not deliver, the risk ultimately falls
back onto the state anyway. State pensions have been reduced too
far, and private pensions have not offset this, leaving half our
pensioners (and three-quarters in future) needing means-tested
pension credit to avoid poverty. This undermines private pensions.
Pension credit claimants lose 40% or even 100% of any private
pension, so locking money into a pension just doesn’t make sense for
basic rate taxpayers. Compulsory contributions in this environment
are surely unthinkable, since pensions are an unsuitable investment
for many people.

We urgently need to change course. Scrapping State Second Pension
and introducing a £110 per week citizen’s pension, indexed to
earnings, would simplify state pensions, ending mass means-testing
and pensioner poverty. The additional £7billion a year cost could be
financed, without tax increases, by the £11 billion savings from
abolishing contracting-out rebates. The age at which this pension
starts could be indexed to longevity. The state would no longer
provide earnings-related pensions, but it is not clear why it
should. If people earned more when working, why should this mean
Government has to pay them more when they are not working?

A citizen’s pension provides a clear division between what the state
pays and what people must do themselves. Once private pensions are
no longer penalised, financial services providers would be free to
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 your savings won’t be
penalised by means-testing.

We then need better pension incentives. Policy has concentrated on
‘supply side’ reforms -informed choice and cheaper, simpler products
– but has ignored demand. People have lost faith in pensions and
don’t want to contribute. Current incentives rely on tax relief,
costing £10billion a year, (half of which goes to top-rate
taxpayers). This is inefficient, opaque and regressive – giving
highest incentives to those who need least. A system of matching
payments, providing the same incentive for the same contributions –
perhaps £2 for every £3 contributed – would be fairer, clearer and
more effective in encouraging basic rate taxpayers to save. If this
were coupled with ‘soft compulsion’ reforms, such as requiring
people to opt out of employer schemes, rather than opting in, or
encouraging them to put part of any pay rises into a pension each
year, evidence suggests take-up would dramatically increase.

Urgent action is needed on occupational pensions. Most final salary
schemes have closed, as they have become unaffordable. Employers
expected strong equity returns to meet these open-ended,
inflation-linked commitments, but they did not. The uncertainty of
this ‘pray-as-you go’ approach has left huge deficits and thousands
of people destitute, despite decades of contributions, which has
undermined confidence.

Contributions to new occupational money purchase schemes have fallen
sharply. With average job tenure around 5 years, employers no longer
feel obliged to provide pensions for their workforce and, if we want
them to contribute, better incentives are required. Compelling them
may have some appeal, but employer contributions have to come from
somewhere. If companies put more money into pensions, then wages,
investment, employment and/or profits must fall. We must recognise
financial reality.

The bottom line is that pensions cannot solve the pensions crisis!
Policymakers should start this debate. Most people will never be
able to save enough to provide a ‘decent’ pension. Pensions were
meant to last 5 or 10 years, but people now expect them to last for
decades. Paying people not to work, when they are able to, is such a
waste of resources and is unsustainable. Just raising the retirement
age is not the answer. A more flexible approach, which can
accommodate demographic change, is needed. Retirement should be a
process, rather than an event. There is a new phase of life, waiting
to be grasped. 10 or 20 years working part-time at older ages. This
is much healthier for individuals and the economy. The policy
challenge is to encourage employers to provide jobs and help
individuals plan for gradually cutting down, rather than suddenly
stopping work completely.

We must radically re-think retirement, abandoning fixed retirement
ages. Pensions could then supplement income, rather than providing a
complete replacement. Gradual retirement, coupled with a citizen’s
pension and better incentives, would finally bring pension policy
into the 21st Century.