When Gordon Brown becomes prime minister he will already have a place in history for having impoverished generations of pensioners. When he arrived at the Treasury the incomes of retired people were rising faster than wages. Britain was breaking the link between old age and penury. Not so now. Before long, two-thirds of pensioners will need to claim means-tested benefits.
Many millions of employees used to look forward to retiring on defined benefits (calculated in relation to their years of service and their pay around retirement age) which would be honoured out of company schemes that were fully funded. But now the pension funds of the UK’s top 350 companies are in deficit by about £75 billion (if you believe the government’s pensions regulator). Companies are rectifying the position by diverting money to the funds and away from investment, and by slashing benefits.
The British tradition of defined benefit schemes has been killed off in the private sector. In just two years from the end of 2001 the proportion of top companies offering defined benefits to new employees fell from about two-thirds to a third. When those people retire their income will be unpredictable, dependent on the rise and fall of markets. Whereas in defined benefit schemes the employee and employer jointly paid into the pension fund an average of 18.8% of the person’s pay, the amount paid into a defined contribution plan is normally about 10 percentage points less. Unlike people retiring now, upcoming generations of workers will typically rely in retirement on a pot about half as large (in relation to their pay).
Brown bears responsibility for what has happened in the private sector for two reasons. Instead of taxing our incomes directly to fund his programmes, he chose to lift about £5 billion a year extra from our pension funds by removing their dividend tax credits. His stewardship has also coincided with a sluggish performance by the UK stock market as companies have suffered from his new taxes and regulations.
Admittedly, the impact on pension funds has been magnified because British fund managers have invested much more in UK shares than is justified by Britain’s weighting among global markets. Also, actuaries made a poor job of forecasting demand. The estimate of how many pensioners there will be in the early 2020s is 1m higher now than it was when the government took office.
The basic state pension has been a problem since its inception because our contributions do not go into a fund that can grow. Those in work simply pay for today’s pensioners through taxes. The last Conservative government kept that burden in check by increasing the pension in line with prices rather than earnings. That hard-headed policy has been continued by Brown. It will be harder to sustain as the reductions in company pensions work their way through. Concern about social justice is also rising. The basic state pension now represents about 16% of earnings. Can it be right that people who all their lives paid for the pensions of others should be so disadvantaged once they can no longer earn?
Brown responded by supplementing poor pensioners’ incomes with additional credits. That draws a majority of retired people into means testing. It also has the effect that if a pensioner’s basic income rises, between 40% and 91% of the increase has to be given back to the government through tax and withdrawn benefit. For many there seems little point in saving or in trying to earn small sums in retirement. Yet despite their disincentive effects Brown remains wedded to “ his” credits.
Last week the chancellor made it clear that he will not accept the recommendation of Lord Turner’s pensions commission to restore the link between the basic pension and earnings. If Turner does indeed suggest that, Brown will think he has over-reached himself. That must be a decision for the government because of the massive implications for its economic strategy. Even to raise the basic pension from £80 to £105 one-off would cost the equivalent of a 3p rise in income tax.
For Brown, maintaining the link with prices (to the disappointment of the Labour party) has been a symbol of political virility. The fact that the Liberal Democrats and even the Tories now want the pension to be linked with earnings makes it almost impossible for him to change tack. In any case Brown needs to recover his reputation for prudence.
By contrast with the private sector, public sector workers can look forward to generous pension provision. The proportion of public sector employees in occupational pension schemes is nearly twice as high as in the private sector: 5m public sector employees can still look forward to defined benefit pensions. The normal retirement age is 60 compared with 65 in the private sector. Firefighters and policemen can take their pensions at 55. Public sector employees’ pensions enjoy another advantage over the private sector because they are fully protected against inflation.
That creates a huge distortion in the labour market. Also, the government’s obligations to public sector employees amount to hundreds of billions of pounds and it spends about 2% of our GDP meeting its annual commitments. It has been negotiating with the trade unions on reform since 2002, but last month Alan Johnson, the trade and industry secretary, capitulated. Existing employees, however young, will preserve the right to retire at 60.
The unions’ opposition to raising the retirement age is unreasonable. The public sector position is out of line not only with the private sector but also with the basic state pension retirement age, which for men is 65. That will also have to go up. When that threshold was established in the early 20th century, life expectancy at 65 was 11 years. Now it is 16. People are fitter for work for longer than they used to be.
Both Tony Blair and Brown have procrastinated over pensions since taking office. They would have done better to take tough decisions when the Labour majority was at its peak.
People are not saving enough for their retirement. We live in a culture of instant gratification. Britain’s current propensity to save is low compared with our history and with most other countries. The changes to private sector pensions will make matters much worse. The government’s attempt to lure low-paid workers into simple so-called stakeholder pensions has been a flop.
Confidence in long-term saving has taken a knock with the much publicised failure by Equitable Life to honour its undertakings to “with profits” policyholders. Many people with endowment mortgages have been told that their policy will not pay off the debt on their home as they had assumed it would. Sophisticated savers know that investing in a pension fund attracts tax relief but limits your freedom to use money as you choose, and if you die too soon you lose the benefits of having saved.
Perhaps, then, it is understandable that Sir Malcolm Rifkind, speaking for the Tories, has described the idea of making pensions saving compulsory as a stealth tax. But it may be the lesser of two evils. It is not acceptable that large numbers will retire with no savings and that a majority will rely on means-tested benefits. That represents a massive tax on the prudent to support not only the poor but also the feckless. The Conservatives, by committing themselves to increase the basic pension in line with earnings (which might be unaffordable) but opposing compulsory savings, seem to have things precisely the wrong way round.
The pensions issue provides an important test of what sort of leader Brown will make. So far he has made it clear only that he will not restore the link with earnings. If he chose to raise the retirement age and impose compulsory saving he would take two of the bravest political decisions in history. That would provide a pleasing symmetry. Because at a time when the population was ageing fast his decision to impose a huge stealth tax on pension funds was an act of almost unprecedented irresponsibility.
He will surely be remembered for devastating our pensions. Does he have it in him to risk his political career in order to salvage something from his blunder? Go on, Gordon, surprise me.
