Britain’s pensions crisis is right “up there with terrorism or global warming as a threat to much of what we value” – and is set to change the shape of the UK economy and society for decades. That was the stark warning delivered this week by David Willetts, Tory spokesman on work and pensions. Willetts argues that the size of corporate pensions deficits (driven by ex-employees living longer than expected) has already brought new uncertainty to company finances, and helps to explain the long bear market in stocks.
Willetts says that unless the scale of the crisis and its implications are better understood – and solutions found – then we can look forward to a grim future of corporate bankruptcies, higher taxes, a less mobile labour market and a crisis of local government – not to mention mass impoverishment in old age. The other grim prospect is of intergenerational conflict, as today’s thirty-somethings rebel against the well-off generation of baby-boomers whose pensions they will have to pay. Looking further ahead, economist Laurence Kotlikoff (in his recent book, The Coming Generational Storm) warns of “fiscal child abuse”, in which future generations are condemned to a future of higher taxes, higher inflation and a permanently lower standard of living in order to pay their parents’ pensions.
It’s easy to dismiss this kind of talk as scaremongering, but the depressing truth is that such a doomsday scenario is only too probable. It’s often assumed that present increases in life expectancy are a demographic blip – a one-time-only payoff from increased wealth and better health – and that gains in life expectancy will soon level off. But instead, actuarial forecasts of life expectancy are being constantly revised upwards. The result is not hard to grasp. If people live longer, traditional pensions can no longer do the job they were designed for – and it is those currently in their late twenties and thirties for whom the outlook is most bleak.
Indeed, as New Stateman commentator Patrick Hosking pointed out recently, this is the generation who seem to have upset the “financial gods” quite spectacularly. Every asset market, from property to shares, has moved against them, and even those who have managed to get a foot on the property ladder will not enjoy the same gains as their parents. This is the “thirty-glumthing” generation who were joining the workforce just as huge numbers of generous final-salary pension schemes were shutting their doors to new recruits. And now, to add insult to injury, they’re being told they may have to work until they’re 70 to fund their retirement.
But the biggest problem is that too many people underestimate how much they will need in their pension pot, and over-estimate the future value of their current savings. According to the Association of British Insurers, only 38% of people are confident they will have enough to live on comfortable – and many of these will be sorely disappointed. For example, research by independent consultant John Chapman in the FT shows that even a typical middle-class 30-year-old with an annual salary of £35,000 faces a rude shock when getting down to pension planning. If he or she relies only on the basic state pension, state second pension and pension credit, his or her pension at age 65 would be £261 (in today’s money). That’s well below the target ‘replacement level’ of £788, or two-thirds final salary. To make up the difference through a personal pension, premiums would need to be a massive £620 a month (or £788 if self-employed, thus losing out on the second state pension, a valuable and under-exploited resource). If our thirty-year old decided to work until age 70, those monthly premiums would be correspondingly lower, at £300 (or £405).
Everyone agrees that the basis of any solution to the pensions crisis is that we must all save significantly more of our income and start doing it earlier. But there’s a big problem of confidence. Presently, one in four of us is not contributing to any kind of pension or savings scheme. Millions more are facing an uncertain future as firms rush to save costs and lower risk by closing final-salary schemes in favour of defined contribution schemes. (In practice, the new method means workers can expect 30% less retirement income, says Close Wealth Management.) Meanwhile, Government efforts at stimulating pension saving have failed to catch on: sales of stakeholder pension (a personal pension with charges capped at 1.0%) got off to a slow start, and fell 22% in the year to this spring.
As things stand, Britons have more invested in housing than in pension funds, according to the Pensions Policy Institute. But if you want to redress the balance, where to start? First, make sure you take advantage of company pension schemes: whatever the flaws, employer contributions make these schemes a good bet for employees. Second, stakeholder pensions were originally targeted at the less well-off, but in practice can be a potentially attractive savings vehicle for many self-employed people, given the low management charges and other statutory requirements. For details of the best offers and fund-performance comparisons, look at www.moneyfacts.co.uk or www.thisismoney.co.uk.