Who pays for our pensions?
Courtesy of BBC News
The forthcoming report of the Pensions Commission could trigger some
fundamental alterations to the pension system in this country.
The commission was set up by the government in 2002, under the
leadership of Lord Adair Turner.
Its aim is to make recommendations on what, if anything, should be
done to improve our pension system.
And the final recommendations will be published on 30 November.
So where, exactly, does the money come from to keep us alive when we
stop work?
State pensions
The biggest provider of pensions is the government itself.
In 2002 the basic state pension paid out nearly ?38bn pounds to
pensioners.
The source of that money is obvious: taxation, National
Insurance contributions and borrowing by the government.
This pays for more than just the basic state pension. It also funds the top-up version now called the Second State Pension
(formerly the State Earnings Related Pension System or SERPS).
Chuck in the cost of giving pensioners a minimum income regardless of
their National Insurance Contributions (the Pension Credit) and housing,
council tax and disability benefits, and the government paid out in 2002
a grand total of nearly ?64bn to recipients.
The problem for the government is that thanks to people living
longer, the proportion aged over 65 will rise considerably.
In fact the Pensions Commission suggests the number of people over 65
will rise by 78% between now and the year 2050.
Too many not saving?
According to the report there are 15 million people of working age
who are making no pension provision at all for their retirement.
So unless they have money under a mattress, expect to inherit
substantial wealth or have other plans - for instance a pension plan to
which they are no longer contributing - they will be relying entirely on
the state to give them an income in retirement.
However a recent study of people in their 50s or early 60s, who have
not yet retired, said they at least would be much better off than Lord
Turner assumes.
The report, by the Institute of Fiscal Studies, suggested this is
because of things like the amount of property this generation owns and
the money they are likely to inherit.
One of the authors, Carl Emmerson, said: "It is a bit extreme to
assume that people won't use any of their housing wealth to spend in
retirement. We assume they will probably spend about 50% of that
wealth."
The IFS concluded that the vast majority of the age group it studied
would have enough resources to provide themselves with a retirement
income higher than the minimum adequate level suggested by the Pensions
Commission.
State pension poverty
Would it matter if Lord Turner is right and millions of people are
relying solely on the government to provide them with a pension?
Well, compared to many continental countries our state pension is
rather meagre.
In France, Sweden, Holland and Spain the average pensioner receives
at least 70% of their working income.
But in the UK the basic and second state pensions provide the average
earner with just 37% of their former earnings from work.
So why aren't all pensioners very poor? Some certainly are.
A retired household can be defined as one where the income of the
retired household members account for more than half of the household's
gross income.
According to the most recent government research (Economic Trends
607, published by the Office for National Statistics in June 2004), the
bottom 20% had an average gross income in 2002/03 of ?7,280.
By far the biggest element of that was the state pension.
Private pensions
There are several other types of pension schemes which give millions
of people additional income when they retire.
Currently 18 million people of working age are contributing to
private pension arrangements (including public sector schemes), or who
have partners who are.
The largest group among them are in schemes set up and run by private
employers, and in personal pension schemes taken out by individuals,
typically the self-employed. And in 2002 they paid out nearly ?18bn to their pensioners.
The occupational schemes have long been part of the UK pension set-up
and are familiar to many workers, especially those employed by big
companies. But they have been changing rapidly in the past 10 years or so.
Many were so-called defined benefit schemes, where the pension payout
was determined by the pensioner's salary and length of service.
But a majority of these have been shut to new joiners because
employers have become reluctant to make the high contributions needed to
underpin their schemes' benefits.
Typically the schemes have been replaced for new staff by so-called
money purchase, or defined contribution, schemes.
With these, the final payout depends on the accumulated investment
return and is not related directly to salary or length of service.
And that illustrates the fact that investing the staff and employer
contributions in shares, property and bonds (glorified IOUs sold by
governments and companies) provides much of the money to fund the
pensions of those in employers' or personal schemes.
By 2002, these funds owned assets worth an enormous sum - ?1,300bn.
Public sector
The same approach to funding - investing the contributions and living
off the return - is also true for staff in two of the big public sector
pension schemes, for local authority workers and university staff.
However most public servants are in pension schemes that are not
financed by any underlying investments.
Civil servants, NHS staff, teachers, fire fighters, the armed forces
and police officers are all in schemes where the pension is paid
directly out of contributions from current staff and their employers.
So to all intents and purposes they are funded by tax and council tax
payers. In 2002 these schemes paid out ?8.4bn.
But that cost is rising and has become very controversial.
So to rein it in, the government has now gained the agreement of the
main public sector trade unions to close the civil service, NHS and
teachers' schemes to new members and replace them next year with new
versions.
New joiners will have to work an extra five years, until they are 65
rather than 60, to gain a full pension.
Similar negotiations are underway about the other schemes.
Is that all?
Income from pensions alone doesn't give us the full story of what
pensioners have to live on.
Earnings from investments and continued employment brought in nearly
?20bn in 2002.
So what does the average retired household actually get to live on?
According to the study by the ONS, the average income for a retired
UK household in 2002/03 was ?14,820. And of that state and occupational
pensions made up most - just over ?11,000.
Despite widespread reporting of the so-called "pensions crisis" not
everyone agrees it actually exists.
In a recent pamphlet for the Conservative Politeia think-tank, the
economist, Professor Tim Congdon, examined the value of all forms of
savings - and by the entire nation rather than just households.
His conclusion? That the country has been saving quite enough for its
collective old age for more than 50 years - and is continuing to do so.
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