Guardian comment: Employers cut pension contributions – dangers for retirement

by Dr. Ros Altmann

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A company announcing plans to cut its standard pension contributions to its workers pension schemes would not normally make the headlines. However when the company in question is Aon – a major adviser to employers on pensions – it is an enormously significant development.

The press release explaining the changes also states that this is being done to stay ‘ahead of the curve’. This clearly heralds that the majority of companies will cut employer pension contributions in coming years.

Employers have been pulling out of pensions for several years. Almost all final salary schemes (where employers contribute around 20% of salary) have now been closed and been replaced with money purchase plans into which the employer pays perhaps 10%. Aon’s announcement signals a cut to 6% but even this level may be considered too high as employers increasingly withdraw from pension provision.

In fact, Government policy is encouraging the trend still further. From 2012, its proposed ‘personal accounts’ will only require employers to contribute 3%. So many employers will use the opportunity to cut pension contributions to the minimum ‘official’ 3% level.

Of course, reducing pension contributions is pretty much the same as a pay cut. However, it is a cut in ‘deferred pay’ rather than take-home pay, so people feel it less forcefully.

But we will all feel the effects in future as the trend for employers to pull out of providing decent workforce pensions is accelerating.

The problem is more acute for the UK because our state pension is so inadequate. We have just about the lowest state pension of any developed country and Governments over the years have relied on good private pensions to supplement the low national insurance payments. If these private pensions do not deliver, then more and more pensioners will end up in poverty.

Perhaps it will help to clarify some muddled pension thinking, to understand what is actually going on.

What is a pension? The word ‘pension’ relates to two very different concepts, but they are often considered the same. The original idea of pensions was social welfare, provided by the Government to prevent older people ending up in poverty when too old to work.

This is very different from the other meaning of pensions – long-term savings – which would normally be a private responsibility.

The confusion has arisen because paternalistic 20th Century employers chose to offer social welfare to their loyal lifelong employees through final salary pension schemes. These offered a specific level of pension and were originally non-contributory. This was employers underwriting social welfare. Over time, however, final salary schemes were also used as a long-term savings vehicle, with employees put their own money in.

For years, these schemes looked successful, and became an integral part of our pensions landscape as booming stock market boosted returns. Employers shouldered all the costs and risks of pension provision willingly, especially as actuaries forecast strong investment returns would fund all the pension commitments.

This allowed the Government to cut the state pension consistently over time, on the basis that private pensions would supplement our low state pension. In the late 1980’s, Mrs. Thatcher even expanded the reliance on equity investing by encouraging people to take out personal pensions. As long as they were invested in the stock market, they were expected to deliver good pension income.

In reality, our whole pension system has been based on a giant gamble on the stock market. That gamble has failed as equity returns have not kept up with bonds or life expectancy. Employers are pulling out of social welfare and the long-term savings vehicles have not delivered. Now individuals are being left to cope on their own with inadequate state pensions and dwindling employer help. This is a disaster in the making.

Meanwhile, of course, policymakers seem oblivious to what is going on. They have their own, guaranteed, taxpayer funded, recession proof pensions – perhaps that has meant they do not recognise what is happening in the rest of the country.

We cannot go on as we are. If private pensions wither on the vine, more people will be in poverty, state means-tested benefits will mushroom and the economy will suffer.

The inevitable consequence of the credit crisis and of employers cutting pension contributions is that people will have to work longer – whether they like it or not.

At the moment we are focussing on disappearing pensions, soon we will be looking at disappearing retirement!