It has become increasingly clear that final-salary private and public sector pension schemes and state pensions are unsustainable.
Due to a combination of people living longer, fewer people working to support those who are retired, increased costs and burdensome legislation and lower predicted investment returns, these pensions look doomed.
I recently met an ex-policeman who was retired by the police at the age of 30. He received a lump sum of 25,000 and his index-linked pension is now 5,000 a year. This pension could well be paid to him for another 50 years or more. Ignoring inflation, that will cost taxpayers another 250,000 on top of the 50,000 it has already cost, Taking inflation into account, the cost will be in excess of 1m.
One of the problems with public sector pensions is that many come from unfunded schemes. What this means is that they only constitute a Government promise not usually backed by any assets and taxpayers pay for them.
Public sector pensions will inevitably be reformed. The retirement age will rise, benefits will be reduced, employer contributions will fall and employee contributions will have to rise.
State pensions are also unfunded schemes and are unaffordable to taxpayers over the longer term. Again, they constitute a Government promise only.
Serps, the forerunner of the state second pension (S2P), has already been downgraded twice. The state pension age for women is being increased from 60 to 65. Further rises in state pension ages for all are inevitable. I expect state pensions eventually to be means-tested.
As for private sector final-salary schemes, many employers have already changed their schemes from defined benefit to defined contribution and employers’ contributions have fallen.
I have recently come across two cases where the ex-employers have offered preserved pension scheme members a tax-free cash incentive to transfer out of their final-salary pensions. In at least one of the cases, the pension scheme was in deficit by 20 per cent. In this case, the deferred member is aged 56 and is very tempted by the cash offered.
This is a difficult one to assess because he could be giving up a good pension for a money-purchase equivalent pension of about half of what he would have got.
The big issue is whether the scheme’s deficit will reduce or grow and, if it were to grow, could the scheme be wound up and leave him with a lower pension than he would have got if he had transferred it into a personal pension? I will leave that one to the actuaries to assess.
What is clear is that companies do not want the burden of final-salary pensions. The deficits are a liability and hamper trading activities.
My prediction is that all such pensions will die over the next few decades and be replaced by money-purchase schemes which will be dominated by Sipps. It is likely that the basic state pension will survive but will be reserved only for the poorest people as it is almost certainly going to be means tested in the future.
I also think pension retirement ages are set to rise to 75 for men and women. Employers’ contributions will fall across the board and employee contributions will rise. Compulsory employer and employee pension contributions will be introduced for group personal pensions or stakeholder pensions.
The Government national pension savings scheme will be a flop as it has been created on the false assumption that low charges are the solution when it is top investment performance that makes the difference. Just look at the experience of stakeholder pensions to date.
My only hope is that the tax advantages of pensions will remain but I am even sceptical about that.
Tony Byrne is financial planning director at Wealth And Tax Management