The last blog outlined a proposed scheme to improve pension provision for all in work, which will now be expanded as simply as possible, although it may get a bit arithy but don’t go away.
The current spend on State pensions is £67bn, made up of £52bn on the basic pension; £15bn on the second / graduated pensions, with a further £29bn or more on welfare pension credit and benefits.
The Pension spend is forecast to rise to £91bn by 2016 and increase steadily at this rate due to projected over 65 population rises. The question is where does the money come from? And the answer unfortunately is from those in work by increases in NI contributions and taxation.
The State solution is to increase the basic pension to the poverty level of pension credit at £140 per week £7,280 pa), abolish the second pension and introduce a further contributory scheme Nest in 2012, which will be compulsory for all not in schemes at present, effectively an increase in NI contributions.
This requires an 8% contribution in a defined contribution scheme to be managed by the State and the major Commercial pension providers, the same people responsible for the present recession crisis. DC schemes are known for their poor and unstable performance and Nest is no exception, projected to give 15% return; on the average £20,000 wage this is a pension of £3,000 giving a poor total of some £10,000 per year.
Such penny pinching measures just postpone pension doomsday, but do offer a good opportunity for a new bold and radical approach, the change to a funded defined benefit scheme where contributions are put aside to build up individual pension pots to give a guaranteed value for money adequate pension.
For the State to put contributions aside and pay existing pensioners would double expenditure and is dismissed as impossible, but if combined with the new and existing contributory schemes it becomes feasible with huge advantages to members and to the State who stand to make cost savings on the same scale as the spending review but with less pain.
The new scheme replaces the State pension scheme but complements existing DB schemes, with a change to funded for the maligned PS schemes and is aimed at all in work who have no provision outside the State.
The new contributions of 8% are matched by an equal NI rebate, which is roughly the amount spent on the basic State pension, some 50% of NI income and these 16% contribution savings buy units which are matched to age and Fund performance eliminating the unfair fund distribution problems of final salary.
It is designed for a forty year saving period from 25 to 64, which allows for work and wages to have stabilised before contributions become due, although earlier savings are possible. In order to allow fund build up and to make NI rebate affordable, entry will be limited to 25 to 44 initially building up to 65 over the 20 year transition when the new scheme pensions then start, becoming fully established 20 years later.
These build up and are aimed at giving a basic pension of £7,280 doubling to £14,500 pa. + inflation at 2.5%, giving a return based on total contributions made; it allows extra contributions and includes a safety net at the minimum level for low and intermittent earners, assuming all in work are paid a basic minimum.
In the steady build up model over 20 years, the State meets existing pension liability for the first ten years and this is progressively transferred to the new scheme to allow the State expenditure to move across to the target level of 50% NI income. In a second model the S2P expenditure is used to increase available NI funds between 15 to 20 years.
A second cleaner approach of instant transfer was also considered which requires the State to create a Pension Bond to meet existing Pension liabilities from age 45 on. A Bond of £900bn with a 4% yield could meet the pension demand with population projections and 2.5% inflation increases, but requires the new scheme to progressively buy the Bond over forty years to make up the balance pension payments.
In either approach the new and existing schemes will subsidise existing pension payments, but those in work will foot the bill anyway, one way or another. The next blog will show the advantages of doing it this way.
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