Pensions – a contract between the generations

March 5 2001

This, as Tony Young [Chair of the TUC Pensions Committee, who also spoke at the conference] stressed, is not just another conference about pensions – it is a first step towards a fundamental change in the way the pensions debate is conducted in Britain.

We are told, by politicians of all parties and by the press, that there are two separate issues: what to do about today’s pensioners, and what to do about tomorrow’s.

A typical example is the Government’s recent consultation paper on the proposed pension credit. Chapter 2 is headed “Providing security for today’s pensioners”. Chapter 3 is headed “Providing security for tomorrow’s pensioners”. What we need is a debate on “Providing security for all pensioners”.

Of course, part of that debate has to be mainly about the needs of today’s pensioners. We want to know what is to happen over the next few years to the basic state pension which remains the main source of income of most pensioners. Are we to be compensated for the losses we have suffered through the breaking of the link with earnings in 1980 – now about £25 a week, even after taking into account the £5 rise in April 2001 (which the Pensions Minister, Jeff Rooker, described in the House of Commons on 29 January 2001 as “the forthcoming massive increase” in the basic pension)? And how much longer must we wait before the earnings link is restored, so that the pension does not continue to fall still further behind the incomes of those in work?

And part of the debate has to be about questions which mainly affect the pensioners of tomorrow. In particular, what future is there for occupational pension schemes and for SERPS – and how satisfactory will the new stakeholder schemes be as an alternative?

These are all important questions, but we cannot arrive at sensible answers by looking at one generation at a time. What is happening to today’s pensioners is not just important for them – it’s at least as important for tomorrow’s. And, at the same time, the plans we are making for the pensioners of 2050 have major implications for the pensioners of today. Let me give a few examples.

First, and most obviously, the basic pension. Recent Government pronouncements have made it clear that at present there is no intention to restore the link. Without it, the pension will fall, year by year, to an even lower proportion of average earnings. It is now about 15%. By 2040, when my daughters are coming up to pension age, it will be 10% (House of Commons, 2001). Instead of the £25 a week that today’s pensioners are losing, the pensioners of 2040 will be losing about £50 a week. Their basic pension will be less than one-third of what it would have been if the link had not been broken.

Young people, therefore, ought to be even more worried than their parents about the implications of current policies. But most of them regard the basic pension as irrelevant to their needs. They have been told “It’s no use relying on the state – if you want a decent pension, you must go out and buy it.” What they have not been told is just what it will cost to buy the kind of pension that good employers offer and that SERPS offered when Barbara Castle introduced it in the 1970s. They assume, reasonably enough, that, if they do what the Government tells them and join one of the new stakeholder schemes, all will be well.

The Government’s own figures, however, show that all will be far from well. Hidden away at the back of the 1998 Green Paper was a table showing that somone on average earnings, retiring in 2050, could expect a total pension, state and private, of £94 a week (Department of Social Security, 1998, p. 105) – roughly the level of the means-tested “minimum income guarantee” (MIG). This is a depressing prospect – and the reason is very simple. While stakeholder pensions are building up over the next half century, the basic pension will continue to wither away. If the basic pension were to be linked to earnings from now on, the average earner retiring in 2050 would get a total pension not of £94 a week but about £130 – not a princely sum, but about enough for a single person to live on.

The message to the Government is clear: restore the earnings link, and your policy for future pensions begins to make sense. Without the link, we face a future in which the living standards of millions of pensioners will depend not on their pensions but on the means-tested benefits by which they are topped up.

Which brings me to the Government’s latest proposal, for a pension credit, intended to start in 2003. The basic idea is that, instead of the MIG simply raising people’s incomes to a minimum level, people who already have some income above the level of the basic state pension will be allowed to keep part of it – 60% to be precise. So, if you save for your retirement but still finish up on the means test, you will at least be better off than someone who didn’t bother to save.

The pension credit is a well-intentioned attempt to improve the situation of a very large number of pensioners who are by no means well off. Some will gain by about £13 a week, or £18 for a couple, though most will get much less than this and those who, for whatever reasons, do not claim their pension credit will of course gain nothing (it is worth noting that the recent intensive publicity campaign has so far picked up only about 80,000 of the 500,000 pensioners believed to be entitled to the MIG but not claiming it (House of Commons, Hansard, 5.3.01, col. 65W)).

There are a number of other snags about the pension credit, of which I will mention only two. The first, affecting today’s pensioners as well as tomorrow’s, is that, according to the Government, the effect of the pension credit will be to more than double the number of pensioners going through a means test – in fact, a half of all pensioner households will be affected in 2003, some 5.5 million pensioners in all (Department of Social Security, 2000, p. 5).

The second snag lies in the implications for young people who are wondering whether and how they should be saving for their old age. There are two ways of looking at the pension credit. One is to say, as the Government does, “You will get a reward of 60p for every pound of income from your savings.” The other way to put it is “An extra pound of income from your savings will leave you only 60p better off.” Looking at it this way, the effect is much the same as a tax of 40p in the pound on single pensioners with total incomes of up to £135 a week and pensioner couples with incomes up to £200 a week.

From now on, therefore, working people who are wondering how much to save for their retirement will have to ask “Will I be caught by the 40% pension credit tax and, if so, wouldn’t I get better value by spending my money now rather than saving it for my old age?”

This is, to say the least, a complicated issue. What is clear is that, in deciding what we think about the Government’s proposal, we need to look at its likely effects on both today’s and tomorrow’s pensioners. Of course we want more money for today’s pensioners – but would that money be better provided in other ways, in particular by raising the level of the basic pension and thus reducing, rather than increasing, the number of pensioners subject to means-testing, both today and tomorrow?

Perhaps the most fundamental issue which should unite workers and pensioners is the future of social insurance: the mechanism through which people currently in work contribute towards the maintenance of those who are, permanently or temporarily, not gainfully employed – and through which, crucially, today’s contributors earn the right to similar support in the future when they can no longer earn and contribute.

It is clear that, at present, the Treasury regards social insurance as an amusing fiction – but a useful fiction which brings in billions of pounds that would otherwise have to be raised through less popular forms of taxation. In theory, National Insurance contributions and benefits operate on a pay-as-you-go basis: the contributions paid by working people and their employers each year are intended to meet that year’s benefit expenditure, leaving the National Insurance Fund with a working balance of one-sixth of annual expenditure to allow for unforeseen fluctuations.

In practice, it does not work like that. Contributions are a percentage of earnings, so the income of the Fund rises roughly in line with earnings; but, because benefits rise only in line with prices, the expenditure of the Fund does not keep pace with its income. For the year 2000-01, the Fund is expected to have received £4 billion more than it spent, which would have been enough to pay for an £8 increase in the basic pension for that year. In 2001-02, the Fund’s expenditure will be increased by the £5 rise in the basic pension, while its income will be reduced by cuts in employers’ contributions; but in spite of this the balance in hand at the end of that year is expected to be over £2 billion more than at the beginning (Government Actuary, 2000, p. 17). These are very large sums of money which working people are contributing for the specific purpose of meeting the current cost of benefits but which are not being used for that purpose. Worse still, today’s contributors know that the benefits will be worth far less in the future, as a proportion of average earnings.

In short, the implied contract under which today’s contributions not only pay for today’s benefits but earn a right to tomorrow’s has broken down. Instead, today’s workers are expected not only to pay for their parents’ and grandparents’ pensions but, at the same time, to pay in advance for their own pensions through private pension schemes. The likely result, as we have seen, is not just poor pensions today but poor pensions tomorrow as well. Even if it could be shown that, by beginning to plan their pensions on the day they start their first job, young people could have a reasonable prospect of retiring in comfort nearly half a century later, is this really the way we want to go? The TUC may want stakeholder pensions built into the national curriculum, as Tony Young told us, but I would rather see young people devoting their energies to saving the planet than poring over the columns of the financial press in the selfish pursuit of maximum returns on their private pension contributions.

Rebuilding the social insurance contract, therefore, is an urgent task which offers rewards for young and old alike. Moreover, while at this conference we are mainly concerned with pensions, we should not forget that the dismantling of social insurance over the past twenty years has had an even more destructive effect on the benefits paid to younger people during periods of sickness or unemployment.

These are some of the issues on which the representatives of workers and pensioners need to speak with a common voice. The challenge that faces us is how to make that voice heard. I hope and believe that, by the end of this conference, we shall have produced some practical proposals for a nationwide intergenerational alliance in favour of a rational pensions policy.

References

Department of Social Security (1998) Partnership in Pensions, Cm 4179, London: The Stationery Office.

Department of Social Security (2000) The Pension Credit: a consultation paper, Cm 4900, London: The Stationery Office.

Government Actuary (2000), Report on the cost of uprating the basic retirement pension in line with the general level of earnings, Cm 4920, London: The Stationery Office.

House of Commons (2001) Hansard, Written Answers, 5 February 2001.

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