A proposal for solving the pension crisis

ASI Fellow and Associate Director of CentreForum Tom Papworth sets out how to solve the looming pensions crisis.

We need to wean people off the state pension. It’s a giant Ponzi scheme that sooner or later will become bankrupt. There used to be five working age people supporting each pension; now there are two, and in the future that number will shrink. It cannot go on.

However, we can’t just scrap it. Too many people have based their future plans on its existence, and it is too late for them to make up for its removal. To tell a 50 year old that they won’t get a state pension is unfair: they’ve worked for thirty years expecting it, and not prepared for a world without it. But I see no reason why we should not tell a 20 year old that they won’t get a state pension, as they have all the time in the world to make their own arrangements.

I have been considering a phasing out approach. Anybody over 60 gets a full pension; anybody under 20 gets no pension. The rest of us see our pensions tapered away at a rate that equals 2.5 percent per year off retirement. Thus, the 50 year old would get almost two thirds of a full state pension, and would have 15 years to make their own arrangements to supplement that amount. I would get slightly less than one third of a state pension, but would have three decades to prepare for a world where my state pension was meagre.

There are two problems with this approach, as I see it. The first is that young people would have to pay in to a system from which they did not benefit. This would generate some understandable resentment. However, we cannot refuse to implement changes on the grounds that certain groups will in the future not benefit where those in the same group but in a previous generation did benefit. That argument, often deployed by students to oppose tuition fees (“You all got a free higher education, so it is unfair to deny it to us”), is the quintessence of Conservativism: a fundamental opposition to change. That same argument, 100 years ago, would have cut the other way: old people benefited from a system into which they had not paid; one generation was being taxed where the previous generation was not. That did not prevent the state pension being created and nor should it have.

I would suggest that we could counter the objection among younger workers in three ways:

  • Firstly, by pointing out that the current system is a lie and that one way or another the state pension is ultimately bankrupt. It is better to taper it out than to reach a crisis point for which nobody has prepared.
  • Secondly, by pointing out that they are in many cases paying for their own parents, just as their parents paid things that they benefited from (such as free childcare) which their parents never enjoyed.
  • Thirdly, and this is perhaps the best bit, by pointing out that over time taxes will be able to fall, so that as they get older the tax burden will be reduced, meaning that they can finance their (probably superior) private pension out of the difference, and probably still be better off than their overtaxed parents.

The other objection that I envisage is that the state pension provides for people regardless of wealth, and that the poorest are not able to afford a private pension. While I doubt that this is as true as those who make that argument claim (in the pre-pension era millions of low paid people made private arrangements though Friendly Societies, cooperatives and other methods), I accept that there will be a demand for some arrangement to help the poorest. This could be achieved by a means tested benefit (like a tax credit) that was paid directly into the pension scheme of their choice. This would also benefit those unable to work for health reasons or due to caring requirements, and would be applied to those signing on as unemployed.

There would of course be a hard core that refused to make arrangements. As long as the above arrangements were made clear, however, nobody would be able to pretend that they did not know that they might face poverty in old age. But no government will be able to ignore that poverty nonetheless. I would therefore suggest that the mandatory retirement age be scrapped, so that a person has chosen not to prepare for their future – or not to do so adequately –can continue working. There may be a case on anti-discrimination grounds for banning companies from having mandatory retirement ages too. Once people became too infirm to work, they could be dealt with through unemployment and/or sickness benefits.

Before anybody accuses me of being callous I would emphasise that honesty from the outset and a tax credit for the poorest would mean that only those who wilfully refuse to prepare for their retirement will find themselves in this predicament. If this is unpalatable, however, then the alternative would be to compel people to make arrangements: a pension could be mandatory for all workers, just as car insurance is for all drivers.

While some might suggest that not everybody would be able to make an informed choice about pension provision, I find this argument unconvincing – and indeed patronising. With the exception of those who are truly not capable of making decisions for themselves (and these are indeed exceptions and should be dealt with separately), everybody is able to make an informed pension choice, just as they make informed investment choices in other areas of their lives.

Some measure would be necessary to ensure that pension funds were not completely at the mercy of the markets. When I signed up for a defined contribution scheme, my pension provider arranged that in the last decade of the scheme, 10% of my funds would be moved each year from riskier, more rewarding investments to the safest investment vehicles (AAA bonds – which I would hope would mean government bonds considering how casually the rating agencies handed out AAA ratings over the past decade). This should ensure that nobody is caught out by a sudden market slump. It may be necessary to make this sort of protection mandatory.

These proposals are certainly a work in progress. Some of the ideas are not original, though the basic plan to taper the pension away is not one I have come across before. I make them in the hope of stimulating a discussion that may help me revise (or even abandon) what has for some time seemed like a good idea.