A senior economist at the Organisation for Economic Co-operation and Development has just said that the UK should scrap state pensions for the richest 5 to 10 per cent. This echoes a proposal made last November in a paper published via the Centre for Policy Studies.
Sooner or later we are going to have to confront the state pension, and ask ourselves what is it for? Fundamentally, is it a benefit paid to those in need, or is it a contractual obligation of the state, established through National Insurance Contributions? The Treasury’s view is that it is a benefit.
A few years ago, NICs (a cash inflow) and state pension payments (a cash outflow) were roughly in balance. Two years ago, a £4.6bn Treasury grant to the National Insurance Fund was required to plug a growing cash shortfall. Last year that grew to £9.6bn. The direction of travel is clear.
Treasury grants are ultimately funded by tax receipts from today’s workers (or by more state debt, which they will have to service). And many of them, particularly younger workers, do not believe that they themselves will ever receive a state pension. So much for inter-generational fairness.
In addition, due to the diversity in UK life expectancy, our universal state pension age is increasingly unjust. The average man in Tottenham Green will die much earlier than a man living in Chelsea, to the extent that the return on his NICs, in the form of state pension receipts, is only about a quarter of that of Chelsea man’s. This is terrible value for money for those who can least afford it.
The traditional approach to controlling the cost of the state pension is to send the state pension age into retreat. But this is politically challenging, and consequently implementation is far too slow to head off a pending fiscal crisis. We need to be far more radical.
End the state pension
The state pension should be put into “run-off” so that, from 2020, no further “entitlements” would be created. Past “entitlements” would be honoured, as the “legacy state pension”, and this should be means-tested (along with the whole range of other pensioner benefits).
Essentially, the most wealthy in society should not receive any state pension at all. They do not need it (particularly those with defined benefit pensions, which the next generation will not enjoy).
A new senior citizens’ pension
A residency-based senior citizens’ pension should be introduced, payable from the age of 80. All non-pensioners in 2020 would be eligible for it, thus the first payments would be made in 2034. Perhaps set at £200 per week, it would be 30 per cent larger than today’s full state pension.
A Workplace Isa and income support from retirement to 80
The senior citizens’ pension should be complemented by a Workplace Isa, to accommodate employer contributions made under automatic enrolment. This would be significantly pre-funded by the state via a 50 per cent bonus, up to a modest annual cap, with no access to assets permitted until 65. The 15 year period until receipt of the senior citizens’ pension invites structured draw down or annuitisation.
Thereafter, the senior citizens’ pension would socialise longevity risk across the nation. There is an opportunity to introduce the Workplace Isa in the 2017 review of automatic enrolment.
The Workplace Isa would be complemented by a robust, means-tested safety net for those who need it: income support should be extended beyond the state pension age.
These proposals could be funded by ending all income tax and NICs reliefs on pension contributions (£48.1 billion last year, 70 per cent of which went to the top 15 per cent of earners), assisted, over time, by the diminishing cost of the legacy state pension.
Michael Johnson is a research fellow at the Centre for Policy Studies