Our pension system is broken. We must tear it up and start again

OUR pension system is broken. The public doesn’t save enough and is forced, for the most part, to rely on the state to finance all or a large part of its retirement years; and even though the government is being much more generous to pensioners than to any other group, and their benefits are now a huge part of public spending, the amounts that many older people have to live on are still meagre, specially at a time of rocketing costs. The only progress has been the increase in the retirement age, which will substantially reduce the government’s future liabilities; but that has been far too slow.

Meanwhile, private pensions have been decimated by idiotic government rules, final salary pensions are finished for younger private sector workers, annuity rates are still very low (in part because of monetary policy) and the entire annuity system is pretty complex and a not entirely satisfactory creation of government regulation. It is no exaggeration to describe the retirement prospects of the vast majority of under 35-year olds as totally catastrophic.

In the mind of many younger voters, there is growing anger at the perceived unfairness of maintaining or expanding welfare and perks for the retired (especially given that many are asset-rich, even if income-poor) but cutting it for the young – a trend described as generational jihadism by some of its proponents. Such feelings are always ugly: it is wrong for the young to be pitted against the old. What we need is a better pension system to make everybody better off, make retirements far more comfortable and to reduce public spending, thus allowing tax cuts. 

One way forward is that endorsed by a new report from the Institute of Economic Affairs. It advocates an Australian-style retirement system: employers over there have to allocate at least 9 per cent of employees’ pre-tax earnings into a personal pension fund, with the share of compulsory savings set to go up to 12 per cent by 2020. There are also additional incentives for employees to save more.

On top of this, the state pension – which is provided out of general taxation – is means-tested; and most Australians who have worked all of their lives are not eligible for it. This is a very impressive and interesting reform; many other countries around the world operate broadly similar fully-funded systems. They are the way forward; the only question is whether compulsion is necessary or whether a voluntary reform is enough. The latter would be best, of course, but the question is whether the moral hazard would be too great and too many people would save too little, hoping to rely on the state’s safety net. It may be, sadly, that given the starting point and our current aversion to savings, that compulsion would be the least bad way forward – we shall see.

The best bit about universal pension pots is that individuals have their own, named stash: it is their money, even though they aren’t allowed to use it for anything else. It would be very hard for any politician or party to seize or expropriate the cash without mass opposition. In the UK context, there ought to be legislation stipulating that no tax or levy could be imposed on private pension pots without at least 75 per cent support in the House of Commons (of course, this law could be repealed through a simple majority, as parliaments cannot bind their successors, but at least there would be a strong psychological block). If ever we get a new constitutional settlement for the UK, pension assets should be formally protected against expropriation. 

Britain’s own Nest system – the new voluntary auto-enrolment retirement scheme – is moving very gently towards a  version of the Australian system. If the roll-out over the next few years is smooth, it will need to be beefed up dramatically. Save, save, save and save some more: that is the only way we will ever extricate ourselves from our giant pensions crisis.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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