Better pensions – how to return to the future

There is a wonderful story about the realism (or pessimism) of young people. A polling company had asked a group of university students whether they believed they had a better chance of receiving a state pension or meeting an alien. Alarmingly for policy makers, a majority believed they were more likely to meet someone from another planet than get even a penny from their state pensions.

The UK government’s debt obligations – even after the limited efforts this government has made to balance the books – resembles an iceberg that our ship of state is steaming full-speed towards. On our current trajectory, in order to meet our future spending commitments and be debt free by 2060, we would need to cut spending by a further 25 per cent or dramatically raise taxes. Without further reform, our state pension system risks under-delivering – or failing to deliver at all – for future generations.

Some tough measures have already been taken. The government has made a good start by raising the retirement age and removing the barriers that have prevented people working and maintaining a private income for longer. As a previous IEA/AEF report has shown, working longer provides a higher standard of living and, often, health benefits from the mental and social interactions that work provides.

However, in order to avoid even tougher decisions in the future that could cause suffering and privation for our vulnerable pensioners, further steps need to be taken in order to fund these obligations. Some small changes to the state system can have both dramatic long-term effects on our debt iceberg, while simultaneously providing people with greater choice over their pension funds.

One such small step is not difficult to find. All it would require is for the UK to return to an earlier successful policy. From Beveridge until the mid-2000s, the UK had one of the most successful private pension arrangements in the western world, thanks in part to a scheme that allowed contracting out of the public system in return for a rebate on national insurance contributions.

Unfortunately, starting with Gordon Brown and ending with George Osborne, successive governments have quietly killed off this formerly successful policy. The numbers speak for themselves – those contracting out through a private pension have more than halved since 1994/95 to fewer than two million. If we are to finance currently unfunded liabilities, we need to encourage alternative schemes of saving.

In our new paper, Growing the UK Pension Pot: The Case for Privatisation, we propose a return to this policy – a system whereby individuals can forego half of their state pension in return for a national insurance rebate. If the state pension rebate were linked to earnings, a 40-year-old would receive a rebate of around £3,000 per year, which they could then invest in their choice of pension fund.

This rebate system would also be equal to the value of the state pension forgone by each person, rather than linked to income or NI contributions, meaning that low-income people and those who are unable to work due to caring responsibilities can also build a private pension pot without relying on the state pension. They, too, can share in the financial freedom to invest their pension as they see fit, as well as the benefits of the higher returns that come from private sector investment compared to even the ‘triple-locked’ increases in the state pension.

This proposed reform – or more like a return to form – would be the first step to getting our pension liabilities under control and would allow all citizens, including the least-well-off and carers, to accumulate substantial private pension funds.

This article was originally published by ConservativeHome.

Policy Advisor to Mark Littlewood

Sam Collins is the Policy Advisor to Mark Littlewood, IEA Director General. Sam has spent most of his working life in the political and charitable sectors in New Zealand, Britain and the United States of America. Working most recently as the Director of The Hope Foundation for Street Children (UK) and currently as Director of The Age Endeavour Fellowship, Sam has previously been Operations Officer and Communications Consultant at the IEA, as well as a researcher at Progressive Vision. Sam has a BA/Hons in Politics and History from the University of Canterbury in New Zealand, and was the New Zealand National Party candidate for Wigram for the 2011 General Election.