The leaning tower of pISA
Pension reform has been delayed but Britain’s ageing problem remains
In 2015, Britain’s population reached its mid-life crisis as the average age hit 40 for the first time. But this is only the beginning. The coming decades will see the elderly rise to prominence like never before.
By 2030, the number of people aged 60 or over is expected to pass the 20mn mark. By 2040, nearly one in four people will be aged 65 or over. And as the millennial generation goes grey circa 2050, the country is in for a shock.
The big unknown is how to fund an ageing population as the (relative) number of income-generating young workers simultaneously falls. The old age support ratio, the number of working age people to every pensioner, is forecast to decrease to 2.9 by 2050, from 3.3 in 2006.
In response, the government has been reviewing the state pension system to see where it can make savings for later years.
The state pension is currently funded on a ‘pay as you go’ basis, that is, through the contributions of the current workforce rather than through any accumulated reserve of previous contributions. Britain’s rising age will make state pension funding a dominant issue, with younger workers likely to become disgruntled at supporting the burgeoning pensioner population.
Another controversial issue is the state pension’s triple lock. The scheme, introduced by the Liberal Democrats (remember them?) during the coalition government, means the state pension rises every year by the highest of price inflation, earnings growth or 2.5%. This sounds like a reasonable policy but the economics are becoming hard to justify.
To combat the black hole in state pensions, the state pension age (SPA) is set to equalise at 65 years old for men and women by 2018.
It will then increase every few months, reaching 66 by 2020. The next planned increase, towards 67, will start in 2026 and conclude in 2028. Although this is all subject to review — experts are warning that today’s graduates may have to work until their mid-70s before retiring.
On the private pensions side, things are equally rosy. The government’s auto-enrolment salary sacrifice policy has bamboozled small businesses, and the 2015 pensions freedom scheme could expose soon-to-be retirees to substantially higher risk.
George Osborne, ever the radical, had planned further shake ups to Britain’s pension system in this year’s budget, but was forced to back down with public pressure and Brexit fears playing on his mind.
Amongst the tabled reforms was the pension Independent Savings Account (pISA). Here, pISA contributions would be made from your (post-tax) cash in hand pay. Meaning contributions are taxed upfront, but you get your full pension tax free in retirement. The current system confers the reverse; we get tax relief on our pension contributions but pay tax on (the majority of) our pension receipts in old age. In theory the pISA would boost government access to taxation revenues without impacting the net return to the public, but it could screw over younger workers if future governments decided on a policy u-turn (in this situation workers could potentially be double taxed). So whether the pISA is an acceptable policy comes down, partly, to how much you trust politicians…
Other rumours that failed to materialise include plans to abolish the 25% tax free lump sum on pension pots and capping the maximum annual contribution at GBP25,000.
It is difficult to say whether such changes are the right thing to do. Britain’s ageing population is a ticking time bomb that cannot be avoided, so something has to change. We need a system that provides a fair standard of living across generations, but that currently seems a long way away. My impression is that the Chancellor’s pension reforms have merely been delayed, and could be revisited as early as the 2016 Autumn Statement. If that is the case, then expect the pension debate to flare-up again before the end of the year.
It is important to note that pensions will be only one element of the adjustments needed to deal with the ageing population. Britain must also face up to reforms in health, housing and social care to support the shifting demographic. These changes could prove to be even more challenging and controversial.
