The state pension is the single biggest item on the welfare bill. The deal behind it is an attractive one – you pay tax all your working life, so at the end of your working life the state gives some of that money back to you. You contribute to your pension. In return you get a decent standard of living in retirement.
But the deal is is based on a con trick. The state pension is neither contribution-based nor enough to live on.
Firstly, the state pension is staggeringly insufficient for elderly people to actually live on. The basic rate pension currently pays just £116 a week. From next year all pensioners will be entitled to a flat-rate £148 a week. That’s just over £21 a day. Could you live on that?
However if you contracted out of the additional state pension you are unlikely to receive the full amount. This is somewhat complicated to say the least, but effectively if you chose to put money aside for a private pension instead of paying extra contributions then you will be punished for it.
Most people already have some form of private pension arrangement, because that is the only way to afford a decent quality of life in retirement. Yet one in seven retirees have no workplace or personal pension savings and will rely heavily on the state pension. This is a scandal.
Part of the problem is that having a state pension can encourage a false sense of security. After all, are we not paying national insurance so that we can enjoy a decent standard of living in retirement?
Well, actually we’re not. National insurance – which was originally intended to fund pensions, unemployment insurance and sick pay – has in practice become a second income tax.
This is fundamentally dishonest. National insurance ought to be abolished or at least merged with income tax. George Osborne is apparently already considering this.
The cost of pensions is staggering. The state pension accounts for £92 billion a year in public spending. This figure is expected to quadruple by the mid-2060s.
Worse, state pensions are unfunded, paid out of current tax revenue. We pay out £110 billion a year in contributions. Yet the government’s unfunded state pension liabilities – the money it owes to current and future pensioners – comes to £4.4 trillion. That figure, too, is growing.
Pensions are becoming increasingly expensive because the generational landscape keeps shifting. Put bluntly, the number of old people is increasing faster than the number of young people. We are living longer and having fewer babies.
The first state pension was introduced in 1908, when average life expectancy was just 47. It was only available to men over 70 (women did not receive it until 1940).
Life expectancy is now 79 for men and 83 for women, and rising. The state pension age is now 65 for men and 62 for women. We are not only living longer, we are also collecting our pensions earlier.
So what’s the solution?
If we stick with the present model, future governments effectively have two options: tax the young a lot more, or pay the old a lot less. Neither option sounds particularly appealing.
Or we could get a lot more radical.
The first thing the government should do is to get its money-grubbing fingers out of our pension pots.
Private pension provision in the UK was thriving until Gordon Brown launched his infamous tax raid in 1997. The move wrecked the industry, slashing £118 billion from pension pots between 1997 and 2014.
It was not the first time a government had savaged private pensions. It would not be the last.
Attacks like this hurt our ability to provide for ourselves. In 1997, a third of private sector workers were in final salary pension schemes. By 2012 this had sunk to one in twelve.
In addition to keeping it’s hands out of the till, governments could also cut public spending to reduce the burden on the taxpayer. There is certainly scope for further cuts (I’m in full agreement with this excellent list, for instance).
State pensions are traditionally immune from government spending cuts, with other areas of spending enduring deeper cuts to compensate. The downside to this approach is that, left unchecked, spending on pensions will continue to rise.
The best option is perhaps the most radical one: privatise the state pension entirely.
Australia has already done something like this. Employers are required to pay a proportion of workers wages into a personal ‘superannuation’ account. Employees are able to choose which funds that money is invested in. Qualifying for the state pension in Australia is based on both assets and income, so as ‘supers’ become widespread the burden on the taxpayer has fallen dramatically.
Chile privatised its state pension in 1981. New workers were obliged to join a new defined contribution system instead of the older defined benefit system. Existing workers had a choice. Most workers are now in the new system. You pay ten percent of your wages into an individual account and invest it in a pension fund of your choice.
In Singapore too, people pay into their own personal pension pots. You have complete freedom to invest the money as you like. The only catch is that having a pension is mandatory.
All of these schemes are fully funded. The money you put in is invested. The investments made are sufficient to make all current and future payments to pensioners.
The phrase ‘something must be done’ is so overused now it’s practically a cliché. But with pensions it is both accurate and urgent. Something must be done.
The state pension doesn’t really work for anyone. Not those who live on it, who are almost all supplementing their income from private pensions, or else struggling to get by. Certainly not those who pay for it, who are being crushed under an insurmountable burden that grows heavier with each passing day.
Moving to mandatory, fully funded private pension schemes makes sense. So does scrapping national insurance or at least merging it with income tax. Taxes on pension funds ought to be abolished or slashed dramatically.
We need a sustainable pensions system that works both for those who rely on it and those who pay for it. The state pension does neither.