Pension apartheid: just how bad are private pensions?

 It’s war.  Public sector unions have promised strikes and hinted at civil unrest if the government tries to cut their “gold plated” final salary pensions.  But the £1 trillion unfunded pension liabilities of the public sector, as reported in yesterday’s Herald, are simply unsustainable. This is going to be an epic struggle.   The unions are right on one thing though: the real scandal is the poor state of PRIVATE sector pensions. 

   The average public sector pension, according to the TUC is a modest £7,000, but look over the other side of the fence and you’ll find that the average private sector pension is much less - around £1,700 a year, according to the Pensions Policy Institute. And of course around a third of all employees aren’t saving anything at all for their old age. But to cap it all, most low income earners who do save into private pensions will lose out in the Pension Credit trap. It is a national scandal.

   If you retire with the average private sector pension ‘pot’ of around £24,000 pounds, you are liable to lose entitlement, through the means test, to most of your Pension Credit, which bumps up the basic state pension from £97 the hardly lavish £130 a week for a single person. Savers can also lose things like housing benefit.   Around five million people who are doing the right thing, saving for the future, putting something aside are simply robbed on retirement because of this means test.  Low earners would be much better spending it on themselves than handing it to the government.  Moneyweek magazine estimate that a couple would need to have saved over £180,000 to escape the negative pension trap.

    It’s only because of public ignorance that the government and the pensions industry have got away with this for so long.  Financial advisers know about the scam, of course, and many have the decency to be embarrassed by it.  They even told the pensions commission chairman, Adair now Lord Turner, in 2004 that they wanted to stop advising people on low incomes to save for retirement for fear of being accused of mis-selling.  But they make their living by charging commissions on private pensions, which erode fund values even further, so they kept quiet after a nod and a wink from the Department of Work and Pensions.

   It wasn’t always thus.  In the 1990s, Britons had more saved in private pensions than the rest of Europe combined, mostly in company schemes. There was so much cash around that firms were taking pension “holidays” because their schemes were in surplus.   But Gordon Brown couldn’t keep his hands off this money pot, and from 1997 he syphoned off £5bn a year by abolishing dividend tax reliefs. Then, in the noughties, a collision of factors trashed private sector pensions:   interest rates fell,  the stock market collapsed and inflation returned.   The current policy of near zero interest rates has been devastating to all savers.   Inflation erodes the value of any savings, whether in a private pension or a building society account by around 5% a year.  

    The equities that underpin the value of all private pensions are also in secular decline - the FTSE is still 25% down on ten years ago.  Add to that the high charges - up to 2% - that pension companies are still allowed to apply whether funds go up or down and you can see why pensions have a bad name.  Anyone who has had the misfortune to have a private pension over the last decade will find that most of it has simply disappeared - eaten up by charges, inflation and falling share prices.  When they see public sector workers retiring early with guaranteed and unfunded index-linked final salary pensions, they are understandably angry - especially since they are going to have to work till they drop to pay for them. Around  85% of public sector workers have final salary schemes against only 15% in the private sector. 

   There used to be many more final salary pensions in the private sector - indeed,  public sector pensions were originally modelled on the best practice of great British companies of old, like BP, ICI, GEC.  These firms used final salary pensions to attract and hold on to experienced staff.  But with globalisation, the collapse of stock markets, and the neurotic search for ‘shareholder value’, corporate Britain came under increasing pressure through the 80’s and 90’s.  The old career structures were broken up and pensions scrapped in favour of “money purchase schemes” in which employees are left to the vagaries of the stock market. 

  Most people aren’t aware of how vulnerable they are now because we are all in denial about pensions.  Many seem to believe that their houses will provide for them in retirement.  Younger workers are too busy paying student loans and trying to save mortgage deposits. Moreover, we have all become obsessed with ‘living for today’ running up debts to pay for iphones, cars and other consumer goods - with the tacit encouragement of the Treasury and the Bank of England who tell people to save and then penalise them for doing so. 

  Only in the state sector is the old pension settlement still in place, though not for much longer.  The contributions public sector workers they have made don’t meet a fraction of the cost of the benefits they receive, so they will eventually have to be moved on to money purchase schemes linked to the stock market.   If they’re sensible,  the public sector unions will realise that this is inevitable and try to get the best deal for their members as they transfer out of ‘closed’ government schemes. The retirement age will then have to rise from 60 to 67 for all public sector workers. 

    But we're all in this together and others should contribute too.  It is surely no longer acceptable for higher rate salary earners to be able to shield  40% of their earnings in pensions.  Pensions are for poor people, and tax relief should be capped at the standard rate.  The annual bonus pool for the City of London is around  £15bn and it’s high time that was raided also. This should be used to restore the value of the  basic state pension which has lost around £30 a week since the Tories axed the earnings link in 1981.  That would reduce the impact of the means test.  But even then the future will be bleak for millions of people as they discover that we've been living in a fool's paradise for decades.   Reality will hit the streets this winter