Chile, Sweden or bankruptcy
No economist thinks the present UK pension system is sustainable. More is promised than can be afforded. It is a pay-as-you-go system in which today’s out-payments to retired people are paid for by in-payments from those in work. As life expectancy increases, so do years spent in retirement. The only way to save it would be to switch to a funded system.
In theory, the UK pension system could be made fully funded and affordable, but doing so would involve major structural reforms, political will, and long-term planning.
In a fully funded pension system, each individual’s pension is funded by their own contributions and investment returns, not by current workers paying for current retirees. Such a system is sustainable in the long term without creating massive future liabilities or placing a heavy burden on taxpayers or younger generations. The State Pension is mostly pay-as-you-go (PAYG), funded by National Insurance contributions from current workers. Workplace pensions (auto-enrolment) are partially funded but often underfunded. And there is a large demographic imbalance because an aging population means fewer workers supporting more retirees.
The hardest part in making the transition plan from PAYG to fully funded is that it requires paying for two systems at once during the transition. Existing pensions (legacy PAYG obligations) have to be funded, alongside funding individual accounts for future retirees.
There are various stop-gap measures that might lighten the burden. There could be gradual phasing by age group; there might be government-issued bonds or sovereign wealth-style funds; contributions might be increased, temporarily or permanently.
Current auto-enrolment minimums of the order of 8% are unlikely to be sufficient, and might need to rise to 12–15% of income over a working lifetime. The retirement age could be raised to reflect increased life expectancy.
A feasible roadmap might keep the state pension but slow its growth by tweaking the triple lock. We could gradually raise auto-enrolment minimums to 12–15% and have mandatory inclusion of self-employed workers
This would constitute a hybrid model with a modest, sustainable PAYG state pension, supported by mandatory funded private savings, backed by stronger governance and investment oversight.
Sweden provides a real-world model because it transitioned from a PAYG system to a notional defined contribution (NDC) model, with a fully funded personal account layer.
Workers’ contributions are tracked as if they were saving for themselves, and 2.5% of income is invested in real financial markets in individual accounts. People were given a choice of five approved fund managers, with a sixth default one set up by the industry for those who failed to choose one before the deadline.
The system has a broad consensus of support in that it has intergenerational fairness and transparent personal account balances.
Chile moved in 1981 to a fully funded private pension system managed by private firms, with workers contributing about 10% of wages into personal pension accounts. The state only provides a minimum guarantee for those who save too little.
Some problems emerged because high fees reduced returns, and low-income workers often contributed irregularly. This meant that many retirees ended up with very low pensions. Reforms are now underway to reintroduce public elements and risk pooling.
The lessons for the UK are that the way to go is to combine a PAYG safety net with funded accounts. Like Sweden, we need a long-term transition with clear timelines, gradual changes, and strong communication. Public trust needs independent, transparent management of pension funds with public oversight.
The choice is present system and bankruptcy no, Chile perhaps with modifications, and Sweden a resounding yes.
Madsen Pirie