October pensions supplement: Going for 'slow money'

Funding old age matters hugely. The UK population has not saved enough for retirement, which now may well include expensive care requirements. Statistics from the Department for Work and Pensions show that 11.9m people are saving too little, and that half of those are less than 80 per cent of the way to their target for retirement income.

Steve Webb, Britain’s most able Pensions Minister in decades, has done well to raise the basic state pension with triple-locked increases, and better still to introduce auto-enrolment in workplace schemes. More than 90 per cent of auto-enrolled savers have stayed in their schemes, beating all expectations.

We need to build on auto-enrolment, learning from the well-established Australian Superannuation scheme, the retirement scheme which has worked so well in that country. UK auto-enrolment contributions are set to rise to 8 per cent in 2017, but we should go further. Australia is already at 9.5 per cent and rising. We need to aim higher, and get there faster. Going to 12 per cent would ensure that another 600,000 people have adequate savings.

Pension tax relief at the marginal rate is a system designed by the rich, for the rich: £25bn out of the total £35bn of pension tax relief goes to higher rate taxpayers. It needs to be less regressive if it is to work as an incentive for the lower paid: a flat rate of 25 per cent would work better and enable government to deploy the money it spends on pensions more effectively.

George Osborne’s budget changes—classic “creative destruction”—will radically change how people use their pension savings to provide income for old age. We support this new freedom, and the financial industry will respond with products that offer sensible, affordable choices between guaranteed retirement income and access to funds via drawdown.

Annuity sales are sharply down, but guaranteed incomes have a clear role especially later in retirement. In the US, people draw cash down first then buy annuities in their seventies. Retirement is likely to become a later, more gradual process rather than a cliff-edge, so flexibility is good. How cash is accessed should reflect retirement spending patterns: typically an active phase is superseded by lower spending, which can in turn be superseded by heavy expenses for care.

The pot can however only be spent once, so the guidance process is hugely important. Guidance needs to be independent, so can’t be left to the industry. It shouldn’t be a one-off at retirement—circumstances change before, during and after retirement. One of the biggest challenges is therefore to get a workable, independent system up and running ahead of the reforms being implemented next spring.

From a macro perspective, the problem is even bigger. The dependency ratio (the ratio of people of working age to pensioners) is predicted to fall to 2.9 by 2050, even after planned increases to the state pension age (it is 3.2 today). We have a severe funding problem in the offing. The state pension currently costs £90bn annually—according to the Office for Budget Responsibility, by mid-century it will cost over £400bn, and this is before factoring in the extra health and care costs associated with an ageing population.

So we need to do two things. One is to increase the state pension age again, and keep doing so in line with rising life expectancy. Secondly, we need to think about property alongside traditional pension savings: housing is a big component of many baby-boomers’ personal balance sheets. The over-sixties have £1.2 trillion of housing equity, and many will have to turn this into income by downshifting or through lifetime mortgages. For this to happen, we need a bigger, better equity release market, and we need to build to deliver much better housing choice for the “last time buyer.”

Financing old age is a personal and a policy challenge at the heart of intergenerational fairness. There are stark choices. The OBR’s 2014 Fiscal Sustainability Report makes clear that funding a fair and affordable state pension will require either a much higher retirement age, or substantially more working-age immigration, both politically difficult.

There are also upside opportunities. More pension saving could drive a virtuous cycle where pensions “slow money” is invested in housing and infrastructure, creating jobs now and facilities to underpin growth for subsequent generations. This would be a huge win that could be delivered by joined-up, long-term policies that focus on our demographic challenges.