The First Step -
Understand the Problem

IS THERE A PENSION CRISIS?

Yes, there is a serious pension crisis: very large numbers of people face a much less comfortable retirement than they expect. But no one is shouting crisis. This is because no one has an interest in doing so. When pensioners face up to a bleak retirement in 20 or 30 years' time, today's government ministers will be long gone; no Chancellor of the Exchequer is going to admit that he helped to kill off final salary schemes by a £5 billion a year tax charge now grown to a massive £50 billion.

Anyone in any doubt about the crisis should ponder the following:

- The government-appointed Pensions Commission calculates that £57 billion will be needed through higher tax and National Insurance contributions (at today's prices) to ensure that pensioners in 2050 are 'on average as well off as today.' That equals about £1,000 for every man, woman and child in the UK.

- 16 million pensioners (half the work force) are facing retirement poverty - surviving on less than 40% of their pre-retirementincome (City bank).

- More than half of adult workers will be forced to rely on state handouts in retirement unless the government adopts the Turner Commission proposals.

- Already, one out of four pensioners live on less than £7,500 a year - under one-third of the average wage (insurance company survey).

- Four out of ten people over the age of 50 have already been forced to delay their retirement because their pensions are inadequate (Saga).

- 12.7 million people, or 45% of the adult workforce, are making no provision for retirement (government survey).

- Three million people are seriously under-saving, and 10 million are not saving enough (government Minister in Parliament).

Only one employer in five is now offering a pension scheme based on final salary (House of Lords Committee).

One could go on: if you work in the south-west of England, you have only a one in five chance of a comfortable retirement - defined as having a retirement income equal to 50% or more of final salary. If you regard hardship in retirement as getting less than 40% of final salary, in the north-east three out of five workers will fall into that group. Over the past ten years the total number of workers caught in the hardship group has grown by five million; the number who can expect to retire comfortably has fallen by nearly 3.5 million.

WHAT CAUSED ALL THIS?

No one is admitting to starting the crisis. The culprits include:

1. The near 50% drop in the London stock market 2000-2003, notably including the dot-corn collapse.

2. Gordon Brown taking £5 billion a year from pension funds from 1997 onwards by ending tax relief on dividends - by now, a £50 billion take.

3. Lower annuity rates, reflecting falling interest rates and inflation. Annuity rates now stand around their lowest level for 40 years, and have dropped by more than half since 1990 - with the experts not expecting any short-term upturn. Many people have been hit by a double whammy - their pension fund is worth less because share prices have fallen and the fund earns a smaller pension because annuity rates have come down.

4. People continue to live longer, so annuity rates are pushed down for that reason. And the UK is not even at the top of the first world's life expectancy table - suggesting that further increases in longevity are possible.

5. New accountancy rules have compelled companies to publish the shortfall in their pension funds (FRS 17) which has probably worried employees and led employers to re-think their pension schemes.

6. Workers are changing jobs rather than staying with one employer for their working life: this has a negative impact on pension entitlement.

WHAT HAS THE GOVERNMENT DONE?

Their important positive move has been to make pensions simpler and much more flexible from 6 April 2006. The effect of the lifetime cap (£1.5 million and rising) and your ability to put 100% of earnings into a pension (cap £215,000 and rising) means, for instance, that people in a company pension scheme can top up their plan significantly. The old 15% salary limit and the earnings cap have gone, along with all the age-based restrictions.

In the year you retire, you can make an unlimited contribution to your pension - though you will only get higher rate tax relief up to 100% of your earnings. You can still take 25% of your pension as tax-free cash when you retire. Otherwise, you have to use the money to provide a taxable income - so many people will take the money!

There is even a benefit for smaller pension funds of less than 1 % of the lifetime cap - £15,000 in 2006-7. You can now take the whole sum in cash, with 25% tax-free; previously, you had to take an annuity if your fund was over £2,500.

Under Gordon Brown's pension credit rules (which Turner wants to change), you should not save at all unless you are confident you can build up a pension fund of at least £50,000:

When not to save - an example (from Mercer)

Alan Wardle, 65, has just retired on a state pension of £60 a week- below the maximum because he did not make sufficient National Insurance contributions. Alan has also built up his own pension fund, worth just over £40,000, which has been used to buy an annuity so as to give him a further £40 a week. (Alan, a cautious soul, paid in £1,200 a year to his fund, which grew at an annual 5%.)

Alan's pension income amounts to £100 a week, so he gets £5 a week pension credit plus a further £13 as the savings elements of pension credit. But poor Alan has a bad deal: because of the annuity which he bought, he misses out on £27 of pension credit. This means that his pension fund effectively brings in only an extra £13 a week. And to get this £13 a week Alan saved £23 a week, so that his pension savings, allowing for the effects of the pension credit, have in reality given him a loss, of between 5% and 10% a year!

He would have been better off - looking at his working life and retirement - if he had not saved to put money into a pension fund but spent £23 a week and relied completely on the pension credit. This is how Gordon Brown's rules penalise savings.

The government, unfortunately, has also:

- raised women's future retirement age under the state pension from 60 to 65 to the great benefit of the Treasury

- proposed a 'lifeboat' arrangement whereby well-run pension schemes will bail out those in trouble - which seems certain to help kill off the remaining final salary schemes

- halved the inflation protection which companies must give pensioners, from 5% to 2.5%

- set up a pension credit scheme which is based on means testing, where one in three miss out.

What about compulsory contributions?

The shift from defined benefit (final salary) to defined contribution (money purchase) pensions means greater uncertainty for pensioners - not least because employers contribute less: 4.3% against 9.9%, according to the government. Even these rates are higher than the 3% of earnings which Turner has proposed as employers' contribution. If all employers move to 3%, company pensioners will lose out.

How we compare

European pensions as a percentage of average earnings:

Holland - 100%

Italy - 83%

Greece - 80%

Portugal - 80%

Germany - 65%

Belgium - 60%

France - 50%

Spain - 50%

Denmark - 40%

United Kingdom - 16.75%

'SLEEPWALKING INTO A RETIREMENT OF RELATIVE POVERTY'

Overall analysis of pensions is important, but what matters is the impact on an individual. Accountants PwC have done groundbreaking work, with the unhappy conclusion that 'many young people may be sleepwalking into a retirement of relative poverty.'

Take John Doe, age 20 in 2000 and expecting to retire at age 65 in 2045. He is paid average UK earnings - currently around £25,000 a year - and will stay with the same employer all his working life (an optimistic assumption nowadays). If John Doe retired today he would probably get a two-thirds pension, or £16,500 a year. But by 2045 his private pension will be worth only about 30% of his final salary (£7,500 in today's figures) which the basic state pension would improve to only 37%. John Doe would have to depend on means-tested payments from the pension credit to bring his pension up to 40% of UK average earnings: that would still give him only £10,000 a year compared to £16,500 now.

Women suffer even more

John Doe has good reason to feel concerned, but Jane Doe is even worse off. Assume that Jane starts on the same salary as John, but takes a career break in her thirties to look after her pre-school age children. When she goes back to work she faces a triple whammy:

- she lost earnings, and therefore pension contributions, during her career break

- she may also have fallen behind in earnings relative to John Doe ('glass ceiling effect')

- she will face a lower annuity rate on retirement, because women are expected on average to live longer than men.

(Lower annuity rates for women may change if the EU insists that rates are equalised for men and women, but the concern is that rates for men then would suffer as insurers compensate.)

When Jane Doe retires at 65 her private pension, for all these reasons, will be only just above half of John's. The state pension and pension credit will help bridge the gap, but at age 65 her total pension will still be around 20% less than John's.

For ordinary people, this is the pension crisis - which Turner's plans will help, if the government decides to put them in place.

The Pension Crisis

 

% of UK average earnings	Private pension		Total pension
in year when age reached	Age		Age
	65	75	65	75
Average earners
John Doe (retires at 65)	30	25	39	36
John Doe (retires at 70)	N/A	40	7	46
Jane Doe (retires at 65 after mid-career break)	19	16	32	30
Low earners - 50% of UK average earnings
John Doe (retires at 65)	10	8	27	26
Jane Doe (retires at 65 after mid-career break)	6	5	24	24
High earners - 200% of UK average earnings
John Doe (retires at 65)	80	65	87	71
John Doe (retires at 55)	33	27	40	37

(All earners assumed to reach 65 in 2045; total pension = private + state pension + any pension credit.) Source: PwC

This example, produced by a leading firm of accountants, highlights the bleak features of the present pension scene, and why this has grown into a crisis:

- The high cost of retiring early: this is the only difference between the two high earners, yet by age 75 the man who retired age 55 is drawing only around half the pension of the other.

- Low earners may be better off staying solely inside the state system. They do not get much from their private pensions (10% or less of UK average earnings) and if they do make private savings, these will be taxed at 40% under the pension credit arrangements.

- Women do badly under the present system: using today's figures, the female low earner would be getting only £6,000 a year by age 75 and the average earner £7,500.

- Both the state pension and private pensions will fail to keep pace with the growth in average earnings: in none of the seven cases is the pension, expressed as a percentage of average earnings, higher at age 75 than 65 (except for the man who chose to retire at 70 rather than 65).

- There is pressure under the present set-up for people to work until age 70 in order to enjoy a decent pension. After five years, the average earner who retired at 70 is almost 30% better off than his opposite number who retired at 65; he is considerably better off even than the man who earned double the UK average when he worked, but who retired at 55.

These figures show that already at age 75, six out of the seven are getting less than 50% of average earnings, and that a majority - four out of the seven - are facing hardship, receiving less than 40% of their pre-retirement income.