A golden pot for all solves the pensions emergency

Rising longevity in recent decades is a resounding success story. But public policy has struggled to keep up. The bean-counters are getting nervous. Growth in the numbers claiming the state pension is outpacing that of the workforce of taxpayers who fund it, creating a big headache for the public finances.

Reform is inevitable, and the Coalition rightly aims to address the looming problem. Its mid-term review last week hinted at plans to put in place “a new mechanism to ensure that the state pension age reflects future changes in life expectancy”. The details are yet to be fleshed out, but if the pension age were to rise in step with life-expectancy, the working age population should brace itself for a big shock.

On current plans, most readers of this article will have to wait until 67 before they can claim their state pension. If only. We’ve not seen the last of the rising state pension age, in fact we’ve barely begun. The age threshold would have to go up by almost one year in every five, on recent trends, just to balance the books. Young adults might only become eligible at the age of 77. While the Government’s proposed solution may sort out the public finances, it will be politically painful and highly inequitable. It’s time to abolish the state pension age and think more radically about 21st century retirement.

Just how costly is rising longevity? Government analysis suggests that a one year rise in average life expectancy for the population of 2030 would cost the taxpayer about £7bn in annual pension payments in today’s money, absent any change to the pension age. That’s roughly equivalent to the entire Ministry of Justice budget, or more than one penny on all income tax rates, just to keep the public finances in balance each time life expectancy rises by a year. Clearly something must be done to keep costs in check.

But raising the state pension age in line with life expectancy is a clumsy solution. Growing longevity isn’t just a fiscal problem, it’s also raising questions about fairness. The uniform age threshold is already highly regressive and raising it will make it more so. Better-off people typically enjoy far longer retirements than the less wealthy. The post-65 life expectancy of a healthy male manual worker in the early 2000s was 14.1 years, while a similar professional could look forward to an 18.3 year retirement. This difference in life expectancy means that the planned £140 per week state pension will lead to the richest members of society getting over £30,000 more in retirement benefits than their lower-paid countrymen.

What’s more, recent evidence suggests that mortality rates are improving faster for the more affluent members of society, compounding the inequity. A higher uniform pension age in this context is only going to hand a greater proportion of pension spending to those who need it least, while cutting the entitlement of the lower-paid. This is hardly fair, not least because a well-paid professional is likely to have greater capacity and desire to work longer in their cosy office than is a Gorbals metal basher. Nor does it make much economic sense to encourage productive workers into retirement.

The uniform state pension age should therefore be not long for this world. The next reform must encourage people to work longer, increase individuals’ control over their lives and get the public finances off the hook for ever-rising longevity. But it must do so equitably.

There is a simple way of achieving these goals. Rather than paying everyone a fixed income from an arbitrarily chosen age – too early for some, too late for others – government should instead give citizens an equal lump sum at the age of 60, leaving them to choose when to take it to an annuity provider to convert into a monthly pension income. Let’s call it the ‘state pension pot’.

Those who choose to work longer would be rewarded with a higher income from their annuitised state pension pot upon retirement. And the new arrangement would be much fairer since annuity providers would reflect the lower life expectancy of lower-paid citizens in a higher annual retirement income. Crucially, as life expectancy rises citizens would get the message that they need to work longer as available annuity rates at a given age decline. The change would therefore obviate the need for a recurring political row about whether a shrinking number of taxpayers should be squeezed yet further to fund longer retirements.

The Government is right to grasp the longevity nettle. But in doing so it must extend personal choice and responsibility, and avoid exacerbating current inequities. The one-size-fits-all state pension age is a relic of the last century. Perhaps the state pension pot is something that politicians of all hues could sign up to.

This article first appeared in The Sunday Times on 13 January, 2013.


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