Resident’s Pension – the way forward

by Dr. Ros Altmann

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UK state pensions need urgent radical reform.

Until the late 1990’s, the UK’s pension system was considered a model for others to follow. We had a strong retirement savings culture which offered the potential of good private pensions to supplement very low state pensions. Either employer final salary schemes, or personal pensions, were expected to deliver good retirement incomes and, despite the ageing population, successive UK Governments forecast that state spending on pensions would remain low.

Unfortunately, this model has failed. At the moment, we have a falling state pension coupled with falling private pensions and final salary schemes giving way to much less reliable and far less generous money purchase arrangements. Despite a succession of pension reforms in recent years, each of which has added complexity, policy has failed to address the inadequacy of pension incomes for those coming up to retirement over the next decade or two.

The latest reform proposals, for both state and private pensions, are based on the Government’s assessment that we do not actually have a pensions crisis at the moment, but that we will have one perhaps around 2020 or so without policy change. This assessment is, in my view, fundamentally mistaken.

We do have a pensions crisis now. What we will have around 2020, as a result of the present pensions crisis, will be a pensioners crisis, as millions of older workers try to retire without sufficient income to support themselves.

Pensions policy has failed and radical reform is long overdue. We cannot rely on private pensions to supplement the inadequate National Insurance pension, which has been cut time and again over the last few decades and is about the lowest in the developed world.

Not only is the state pension too low, it is also mind-bogglingly complex. We have a basic state pension (BSP), second state pension (S2P), plus many other benefits, each with different qualification, contribution and accrual criteria. Even after a lifetime of ‘contributions’, a full BSP pays only around £97 a week. Some pensioners have S2P, but for many this will still not bring them above the £130 a week pension credit level, so that between 40% and 50% of pensioners need means-tested benefits to avoid poverty.

In fact, the national insurance contributory principle has been heavily undermined by the mass means-testing in our state pension system. Anyone who has never contributed at all can still receive £130 a week from age 60 (as long as they do not have any other private income), making the BSP of just £97 a week irrelevant – and also resulting in a significant disincentive to pension saving.

The current pensions crisis is partly due to confusion of the objectives of pensions. The word ‘pension’ relates to two very different things.

On the one hand, ‘pensions’ are social welfare – money paid to older people to avoid penury when they cannot work. This would normally be a Government role.

On the other hand, we also use the word ‘pension’ to relate to a special kind of long-term savings – money locked away by workers until later life to provide a better retirement. This would normally be the private individual’s responsibility.

However, these two roles of pensions have become confused.

Part of the reason for the confusion is that 20th century employers established final salary pension schemes that covered both these aspects of pensions. Increasingly, Government transferred additional pension responsibility onto employers and, over the years, employer final salary schemes were required to provide spouse cover, revaluation and inflation-linking that are taken care of by the state in other countries. Final salary schemes also collected contributions from workers, who were then not allowed by Government to have any other pension savings. Workers thought their futures were taken care of.

For many years, our system was considered a success. Cuts in UK state pensions were predicated on having good private pensions and these good private pension expectations were based on investing for the long-term in the stock market with high equity returns delivering generous pensions.

Unfortunately, Governments relied too heavily on employers and stock markets to provide good pensions. But, with increasing longevity, constant corporate change and unreliable equity returns, employers and private pensions cannot provide enough income.

The Government’s latest reforms are an improvement, but not a solution. Much more radical change is needed.

We should separate the social welfare function of pensions from the long-term savings aspects. If the state takes care of basic social welfare, without mass means-testing, then individuals can safely choose to save in a pension, or keep working, without fear of being penalised by a means-test.

I believe all pensioners should receive a decent state pension, irrespective of their so-called ‘contributions’ via the waged labour force or complex credits. The reforms underway will not wholly address the disadvantages for women and carers, or the extent of means-testing.

These problems could be overcome by merging BSP and S2P and paying every pensioner at least the pension credit level, linked to average earnings increases every year – a simple, uniform payment at least at pension credit level for every resident over a certain age, without complex form filling, or qualification criteria.

We can afford these changes within the envelope of current spending, if we redesign other parts of our pension system. For example, if abolishing contracting out, would save several billion pounds a year. We could pay the resident’s pension from age 70 or 75, and at least end the means-test for the oldest pensioners, as well as ending the mandatory requirement for pensions to be annuitised.

Because our state pension is by far the most complex in the world and one of the least generous, it does not provide a stable base on which private savings or part-time earnings can safely be built. We need to radically reform pensions before today’s pensions crisis turns into a pensioners crisis. With the baby boomers about to hit pension age, the time to rise to this challenge is now, not in 20 years’ time.