Unions are recommending that the government introduce compulsory pension saving for all employees. Such a policy change would make a bad situation even worse, prolonging the current system and postponing the required overhaul.
Our pension system is not working properly, and just compelling people to put money into it will not make it work better. The knee-jerk panic reactions to bad pension headlines, like pension credit as a reaction to the 75p rise in basic pension, make things worse.
We need to radically overhaul the way we think about pensions. We have a retirement problem rather than a pension problem. We are trying to make pensions last too long. It is simply not possible for average earners to save enough during a relatively short working lifetime, to support themselves at a decent income level for 20 or 30 years of retirement. Saving 15 per cent of salary for 30 years will not generate a generous pension to last 30 years.
Compulsion is not the answer. In fact, there are many reasons why it could make things worse.
Compelling people to save 10% or 15% of their salary would be devastating for economic growth, as the Australians found when they introduced compulsion. The sudden diversion of income from consumption to savings would be likely to damage growth severely.
Even saving 10-15% of salary will not guarantee a decent pension later on. People could end up severely disappointed by the amount they receive, since pensions are trying to last longer and longer.
In the current policy environment, compulsion cannot be considered at all. Extensive means testing of older people (more than 75% of pensioners will be entitled to pension credit by 2040) will reduce any final pension income by at least 40%, and for many people could even tax away the whole of the pension. For the majority of the population, pensions are not a suitable product and saving in a different form would be much better.
There is little evidence that compulsion works. It does not appear to raise the overall savings ratio, but redirects saving from one form to another.
Compulsion would be seen as another tax. Even if the contributions only come from employers, this must either reduce take-home pay (if employers keep salaries the same and put 10% into a pension instead of into the pay packet) or job security (if employers are forced to absorb the cost of high contributions).
We already have compulsion, in the form of National Insurance contributions. These would be better used to provide a higher pension, and do away with the means testing for older pensioners.
We are wasting huge amounts of money. We spend £38bn on the basic state pension, but over £20bn on pension tax relief and National Insurance rebates. Diverting the expenditure would free up significant resources. Pay the Minimum Income Guarantee level to everyone over 75, probably on a residency test, and tax it back from those with higher incomes. More than 70% of the over-75s are entitled to MIG anyway.
This could easily be funded by reducing the costs of administering the means test of pension credit – £4 per week, per claimant – plus the phasing out of contracting out. This simple change would be of enormous benefit to pensioners, establish a firmer foundation for encouraging longer and more flexible working lives, and have the following advantages:
1. Abolish the means test for the elderly (defining elderly as over-75).
2. Abolish poverty among the elderly (would pay everyone the MIG, no take-up problem).
3. Establish a clear distinction between the state pension and private provision.
4. Remove the complexity of contracting out (no other country does it and it hasn't worked anyway. Thousands of people who received a contracting out rebate and invested in a pension are being left with less than they would have received from the state – what a waste of public money.
5. The over-65s would still be entitled to the means tested MIG and pension credit, but it would be subject to a means test. This would encourage people to work longer and still target resources at those most in need (it is the older pensioners who are least able to cope with forms).
6. It would make a difference to the pensions of older women. At last, elderly single women – the biggest group in poverty – would be looked after properly.
This overhaul would be affordable because it would redistribute expenditure, and effective because it would not depend so much on means testing, claiming and encouraging take-up.
Ros Altmann is an independent consultant