The phrase ‘pensions timebomb’ is as familiar to us now as the price of milk. But with familiarity comes complacency. A 2012 report by the IMF estimated the cost to be £750bn by 2050, representing a rise in UK public sector debt from around 75% of GDP to 135%.
Democratic governments on harnessed to the yoke of election cycles are notoriously short-termist in their policy. What caused this ticking timebomb? And is enough being done to defuse it?
What builds a bomb
The narrative of an ageing population has been well established for years, and it is well understood that this is what lies behind the looming pensions crisis. But there is more to it than just the narrowing worker to pensioner ratio.
For starters, the IMF report contends that official estimates of increasing life expectancy are off by an average of 3 years. This is no small matter. Spread across the population, those extra 3 years are worth billions, including both direct state spending and state bailouts of private funds that underestimated.
Add a population growing faster than previously thought, due both to natural increase and immigration, with an increasing proportion of pensioners, and you have a crisis waiting to happen.
The economics of it all
The bomb building doesn’t begin and end with population trends. Economic circumstances have heavily impacted as well.
Recently, the financial crash has concocted a perfect cocktail of low interest, low investment yields and high inflation – dramatically reducing the value of pension pots and forcing many organisations to pump more money into generous deals from yesteryear in order to meet legacy contract requirements. This has already caused some voluntary organisations to fold. Meanwhile PwC attests there are more ‘pensions blackholes’ in the FTSE 350 than public accounts reveal.
The strain of meeting pension obligations has seen the entire private sector shift almost entirely from defined benefit schemes to defined contribution for new hires; using whatever means they can to move those on the previous regime to less generous packages.
The public sector is making similar moves, shifting from pensions based on final salaries to schemes pegged to average earnings over the long-term.
How prepared are we?
These myriad factors are all contributing to what is undoubtedly a serious problem that is already starting to blow up on us. So how prepared are we?
As individuals, not very. According to insurance and pensions provider Aegon, around 36% of current 16-64 year olds don’t have an active pension plan in place. 31.7% of over-55s admit to not knowing how much they’ll need to live comfortably when they retire, with 24.1% of the remainder only having a vague idea.
When rising living costs and stagnating wages are making it harder to get by on a daily basis, these findings are unsurprising. And although the introduction of auto-enrolment into workplace pensions is undoubtedly a positive move in ensuring the majority have some sort of pensions provision, there is a danger that many will labour under the assumption that they need do nothing further, which is patently untrue.
Using the financial provider Fidelity’s pension calculator, we can see that for a modest annual retirement income of £15,296 (basic cost of living, plus dining out every two weeks, plus theatre/concert tickets) you would need to save a total of £922,000 over and above the state pension. Workplace pensions alone are highly unlikely to provide that.
What can be done?
On to the million dollar question. All else being equal, longer retirements and a higher proportion of retirees vs workers means stretching less money for longer. That is clearly unsustainable.
The ageing population means the tax base will reduce, so raising more cash on a public basis is impossible. The answer is to encourage more private saving, which is where auto-enrolment comes in. But awareness is clearly an issue. It seems that much of the population is sleepwalking into a twilight of poverty. More needs to be done to educate workers on the realities of retirement without a private pension.
If we can’t raise more cash, then we need to maximise the efficiency of what we do have. That’s what lies behind the move from generous final salary packages to defined contribution and average salary schemes. It’s also the reasoning behind higher retirement ages and the single-tier pension. But the government could go further.
For example, a much lower cap on pension tax relief and a flat-rate of 30% – rather than using the current system of pegging tax relief to your income tax band – would redistribute tax relief to where its most needed, without adding to the Treasury bill (seeing as higher rate taxpayers receive the majority as it stands), effectively reducing the total amount low and medium earners need to save.
Both ideas have been floated by the Pensions Policy Institute (PPI), but have met with considerable opposition from those who stand to lose – much as with public sector pension reform. Maybe they aren’t the right solutions. But the problem is too big to tinker round the edges. As sizeable as the pensions bill is, we haven’t even considered the cost of care here. This is a radical problem that requires radical solutions, and we can’t afford to put it off. Tomorrow is too late.