The great pensions panic

With UK employee pension schemes fast becoming a thing of the past, Paul Rogerson finds that today's workforce should begin saving for their retirement right away

�Never grow old� if you vote for a Conservative government, Neil Kinnock warned the UK electorate in 1983. Twenty years on, and with one of his own political heirs in office, the former Labour leader�s warning retains a grim resonance. Pensions minister, Ian McCartney, gave the game away recently when he acknowledged the �crisis� afflicting retirement provision. It was the first time a New Labour Government minister has used the �c� word in the context of pensions. But McCartney can hardly be accused of hyperbole. The problem is acute and multifaceted. And though everyone agrees that something must be done, there is no consensus over precisely what.

The UK�s rapidly ageing population - the number of over-50s will rise by six million over the next 25 years - is facing a quadruple whammy.

First, while we�re living longer, the number of working people expected to help support our retirement is declining. For the first time, the 2001 census found, the proportion of UK adults aged over 60 is higher than the proportion aged under 16.

Since Margaret Thatcher severed the link with earnings, meanwhile, the state pension has withered on the vine. At a maximum of £75.50 a week for a single person or £120.70 for a couple, it is inadequate to fund a comfortable retirement. It is likely to become more inadequate, although Gordon Brown has muddied the waters by bolstering senior citizens� income through a clutter of means-tested benefits.

Successive governments have delivered a clear message that individuals must take responsibility for their own welfare in old age. But that message has failed to get through, partly as a consequence of the pensions misselling scandal of the 1990s.

Half of all men and about a quarter of women expect to retire early, according to the Financial Services Authority, but a substantial proportion of them have no pension provision. Of those who do, millions are not saving anything like enough. Recent estimates of this �savings gap� range from £27bn a year to as much as £70bn.

The recent stock market crash has further discredited the notion that we should all be funnelling hefty sums into pension schemes. Most schemes channel 70% of their members� money into equities and collapsing stock markets have devastated the value of these funds. In 2002, according to performance monitor Russell/Mellon CAPS, the average fund lost 11.3%, the third successive annual decline - itself a record.

According to Morgan Stanley, there is now a £85bn �hole� in the country�s biggest companies� pension scheme accounts, equal to nearly 10% of their market capitalisation.

Not only do these statistics bode ill for people approaching retirement, they are also bad news for people at an earlier stage of their working life who hope to guarantee a comfortable retirement through an occupational scheme.

Today�s pensioners are the fortunate generation, many yielding the accumulated benefits of defined benefit plans, universally regarded as the �gold standard� of pension provision. As few could fail to have noticed, these schemes - which offer employees a guaranteed proportion of their final salary on retirement - are being scrapped or suspended in droves.

Companies scrapping final salary schemes blame the markets and FRS 17, the accounting rule which forces companies to be more transparent about their pension liabilities. But it is hard not to be sceptical, at least in some instances. UK Plc did not complain when double-digit stock market rises allowed it to take contribution holidays. And although many top companies continue to rack up healthy profits, they are proving reluctant to pick up the pensions tab now that shares have dipped.

Egged on by benefits consultants, many firms are replacing defined benefit schemes with so-called money purchase schemes, transferring the investment risk to the employee. Worse, when employers do switch, they slash their contributions by an average of 40%, equivalent to cutting staff pay by 4%.

The upshot of all these developments, as the Government has stressed, is that UK employees will need to work longer, save more, or both. Raising taxes to restore the link between the state pension and earnings is, we are told, unaffordable.

For the moment, ministers have ruled out raising the retirement age to 70, arguing that it would adversely affect people on low incomes. But Labour�s six-year-old strategy to get people saving for retirement - the stakeholder scheme - is an embarrassing flop. McCartney admitted to MPs recently that, although 335,000 employers had set up company stakeholder schemes, a �significant proportion� have done nothing other than simply register to comply with law. The vast majority of schemes - as many as 90% - are empty shells with no members.

As far it goes, December�s Green Paper on pensions (see above box), the latest landmark in the debate, was broadly welcomed. But industry figures remain disappointed that the Government is unwilling to grasp the nettle on politically difficult issues such as the long-term role of state provision and compulsory additional contributions.

Leading expert Malcolm McLean, chief executive of the Pensions Advisory Service, told accounting & business: �There�s going to be a real crisis in years to come when millions of people enter retirement without an inadequate income. Compulsion may have to come. Stakeholder pensions are good products, but they will never solve the problem of what to do about young working people who don�t want to save or simply can�t afford to do so.�

For McLean, the fact that the Government should continue to fudge on pensions is depressing but understandable. There is little political capital, for example, in forcing people to part with a sizeable chunk of their disposable income when the benefits of doing so won�t be seen for years. Small wonder, perhaps, that a so-called �voluntarist� approach is to be given yet another chance. He added: �One of the problems is that the Government operates in one-year cycles. But a responsible government must address the problems of future generations as well as the present one.�

Simplified payouts

McLean�s alarm at the slow pace of change is also frustrating the National Association of Pension Funds. It wants to see a rise in the retirement age to 70 and pension payouts simplified. The current system of income guarantees and tax credits should be scrapped, it believes, and replaced by a single �citizen�s pension� paying a flat rate of £100 a week. This would rise in line with earnings.

NAPF spokesman, Andy Fleming, commented: �There� s nothing in the Green Paper one can really argue with. The snag is it will be at least 16 months before anything happens. We�d like them to get cracking sooner.�

There are other options floating around. Former minister Frank Field�s UK Pensions Reform Group is sceptical about relying on a state scheme which is subject to the vagaries of taxation policy. It wants to combine state provision with a funded scheme, to pay a guaranteed pension of between 25% and 30% of average earnings when the scheme matures. Contributions would be compulsory, and also redistributionary to help the lowest paid.

The TUC would like employers to foot the bill for most of the pensions shortfall. Policy officer, Tom Powdrill, said: �The only way the pension system can be sustained is by a core state element linked to earnings, with a compulsory element on top. There should be minimum levels of contribution into money purchase schemes - possibly 10% for the employers and 5% for the employees.�

While industry bodies and interest groups bicker over the broad sweep of pensions policy, they are unanimous in one respect. The time for tinkering at the margins is over.

While MPs listen sympathetically to the worst fears of their constituents, they can at least take solace in their own insulation from the crisis. A Commons standing committee has raised the rate of MPs� pensions from one-fiftieth of their £55,000 salary for each year of service to one-fortieth, partly at the expense of those same constituents.

�This is not a case of MPs enriching themselves at the expense of the taxpayer,� insisted Conservative MP John Butterfill, the pensions committee chairman.

We must hope that MPs prove as solicitous of the wider population�s retirement prospects as they are of their own.

Paul Rogerson is a business journalist. He was regional business and financial journalist of the year in 2002's UK Press Gazette awards.