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This essay is about UK pension provision, but it is as much about looking at the way our parliamentary system works and the impacts of a major change in just one policy area. However odd, it is intended to raise some questions and hopefully designed to provoke thought, in that regard it is the first of 3 essays – Background, Alternatives and the Political Dimension.

In order for me to explore some ideas, I need to set the background which means laying out the current situation in the UK on pensions before I can project a different course of action. Yes, pensions are boring but I don’t want to sell you one, I just want to broadly describe the terrain so that you can form your own opinion.

Pensions As a Topic

The perennial problem with pensions as a topic is the fact that “pension planning” for both the individual and therefore parliament, is something that takes up to 40 years to deliver and politicians cannot and will not see beyond the next General Election. In all fairness, neither will young people who at the age of 20 which is an ideal time to start pensions saving don’t, because they just cannot imagine being 60 or 70 years old.

The Systems We Have

I will not even attempt an in depth explanation of each system, instead and deliberately, I will go for a broad outline and the key points.

There is the State Old Age Pension plus various generations of enhancements such as SERPS and so on. The State Pension although not generous being still at around 25% of the average industrial wage as when first introduced by Lloyd George, is enhanced and exceeded in real terms by a range of means tested bolt ons.

The key to this is that in practical terms “Today’s Taxes, pay today’s Benefits”, there is not and never has been an investment fund to cover this. Now clearly between people living longer, the fact that OAPs are probably already the greatest consumers of the Social Security budget, this situation will only get worse or, the burden greater on the workforce and taxpayers of the future.

Public Sector Pensions

Public Sector final salary schemes which cover everyone from civil servants, teachers, armed forces, police and emergency services, right up to MPs and there are variations. Although members make personal contributions during their working lives and an “individual fund” has to be identifiable for transfer values and so on, these are not fully funded schemes and therefore also a case where today’s taxes provide today’s benefits.

There is an additional problem in that most if not all are indexed in retirement so that the increased longevity of the population will also be a major burden on future generations of taxpayers. Whilst there will be variations the majority of public sector schemes consist of two elements or schemes, a pension and a tax free lump sum.

The pension is based upon 1/80^th of final salary for each year of service which equates to a 50% pension after 40 years. The cash element is 3/80ths for each year of service so that after 40 years of service a lump sum of one and a half times (150%) the final salary can also be taken, tax free, the pension is of course taxable. In fact with variations, this also has created a framework for the structuring of private pension provision.

Private Pensions

Company Final Salary Schemes were very popular, pretty easy to set up originally and not too onerous to fund if you had a young workforce because the majority of the contributions were derived by diverting a percentage of National Insurance Contributions to the fund which were then topped up with contributions by both employees and the host company which had set up the scheme.

These schemes were fully funded and designed to achieve a percentage of final salary for the employee based upon years of service and whilst modeled on the public sector pensions, were slightly different in that there was just one scheme, pension only and based upon 1/60^th for each year of service which meant that a 2/3rds of final salary could be achieved after 40 years service. It is possible for an employee to take a tax free lump sum up to the maximum allowed of x 1.5 final salary but that will also reduce the amount of pension paid.

Whilst the best schemes would increase pensions in retirement from time to time, normally that was always at the discretion of the Trustees and dependent upon the overall ‘health’ of the pension scheme where it was self-administered, fully insured schemes might differ. However and quite apart from the strange ravaging of these schemes by Gordon Brown and his £5 billion a year tax impost upon them, they were also vulnerable anyway in an ever faster moving economic climate where the long term stability of the number of employees and profitability that makes planning possible when looking forward 20-40 years at a time.

Gordon Brown was a lunatic to have finally destroyed Private Final Salary Schemes through his £5 billion a year tax raid but strangely, he might have accidentally done us all a service if we have the wit to grab it although the consequences will not be to his liking.

The Problem

What I have described above are what are called “emerging benefit schemes” which means that the scheme promises to pay the pensioner some kind of formula based upon their final salary/earning – the benefit. The trouble is, how can a Pension Trustee calculate how large a fund is needed when the combination of future profits, number of employees, their ages and whether the business will still exist or, exist as an independent entity in 5 years time ?

In the private sector and a fast moving commercial world, it is becoming next to impossible so schemes have had to change or, been closed to new members. In the public sector, the government’s solution has been to just write a huge blank cheque on behalf of future generations of taxpayers, some not even born yet.

Private Pensions – Money Purchase

Although these types of schemes can and have been used as “final salary schemes” I am deliberately going to ignore the details because it gets mind numbingly boring to explain it all in detail. Instead I’m going to concentrate on the two relevant aspects which make them different to final salary schemes. Just how contributions into them are regulated and the specifics of what pension can be drawn from them and when, are not crucial to the concept and for that matter neither is tax relief on the contributions and subsequent growth.

In a final salary scheme, the “promise made” concerns the outcome 25%, 50% or whatever of the person’s final salary or earnings. Money Purchase schemes are different in that you save a specific amount of money each month, over the years the fund accumulates and grows so that on retirement you have a pension fund which you can then use to buy an annuity (pension).

Annuities are in fact “reverse life assurance” so a younger person may only get an income of 2% pa as a pension on their fund, whereas someone older with exactly the same size fund might get 8% because they won’t live as long.

So the “promise” with money purchase schemes is just an accumulated fund and no guaranteed outcome. Now whilst that may not sound attractive, it is realistic and also highly flexible because it is related to earnings and not who you are employed by. Although often referred to as Self-Employed or Personal Pensions any employee not in a final salary scheme already, can have one.

So, broad brush I agree, that is roughly the current UK pension situation and I hope that I have at least bought into the picture that currently, none of these arrangements is ideal and I would suggest that in no small part, this is due to that fact that the whole concept of “Pensions” is wrong and needs to be brought to centre stage. Looked at from a slightly different angle and with some changes in government policy, we can achieve a broader and more immediate beneficial change for everyone.

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