OPINION: Increased life expectancy requires better state pensions

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Increases in life expectancy will have implications for state-funded pension schemes, argues financial expert Peter Sharkey - Credit: Getty Images/iStockphoto

In 1994, the World Bank published Averting The Old Age Crisis, a document which, though it failed to generate much publicity, has proved remarkably prescient.

Addressing future pension-related problems in industrialised countries, it asked: “Why don't people simply save [more] when they are young so that they can maintain a decent standard of living when they are old?”

Answering its own question, the document continued: “People may not save enough when they’re young because they’re short-sighted. They may not expect to live long, or they may place a much higher value on consuming today than on saving for tomorrow... It is difficult for 30-year-olds to anticipate their needs when they reach 80.”

I suspect there are few 30-year-olds more focused on "anticipating their needs when they reach 80" than on having a good time while they’re still young. And who can blame them?

The problem of increased longevity was only beginning to be recognised 25 years ago, but the World Bank correctly identified the potential dilemma caused by an imbalance between future workers and retirees when it came to pension benefits. Statistics show how accurate the World Bank’s predictions were. The most recent UK life expectancy data suggests that girls born in 2020 can expect to live until 2110, while boys should live until 2107.

There has been a slight slowdown in UK life expectancy rates recently as we appear to have entered a period when rates have begun to plateau, a phase that was always going to arrive. After all, we cannot live forever.

For more than a century, the UK has enjoyed massively improved standards of living and medical care. Indeed, the most significant rise in male life expectancy came between 1900 and 1950, when it rose by 40pc. Female life expectancy increased by 34pc over the same period. Since 1950, the figures are, respectively, 19.6pc and 15.5pc. Note that the percentage rate of increase in life expectancy has more than halved since the NHS was established in 1948.

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Increased life expectancy is to be celebrated, but only if the state pension system is constructed to accommodate the need to pay pensions to a growing number of folks and for a considerably longer period.

And here’s the rub: it isn’t. Pensions are paid out of current taxes. National Insurance Contributions (NIC) are an income tax by any other name. The money deducted from your salary isn’t ring-fenced in a special retirement account and invested to provide pensions for those aged 66 and over.

It never has been – primarily because when the state pension scheme was established, there was no need to invest in the NICs. In the 1950s and 1960s, most folks died within three to five years of retiring, which meant that paying pensions out of current tax income was a feasible option.

This situation has changed dramatically since the mid-1970s as the ratio of tax-paying workers to retirees has narrowed. Furthermore, the number of retirees is scheduled to continue growing at an unprecedented rate until the middle of the century at least.

France, Belgium, Germany, Austria and Spain all operate ‘pay-as-you-go’ state pension schemes. Each is running out of cash faster than it can be replenished as workers retire and expect a return on their contributions into what has been described as a “series of giant Ponzi schemes”.

The main beneficiaries of NIC-funded pensions will be baby boomers who can look forward to a relatively comfortable retirement, although the same is not true for anyone aged under 45.

Over the coming 15 years, it’s likely that dramatic measures will be implemented to ensure there’s enough cash to fund state pensions. These include:

a) Cutting state pension payments in real terms.

b) Increasing taxes for those in work.

c) Raising the official retirement age. In 2014, a retirement age of 74 was mooted for those born after 2011, so we can expect the retirement age to be 75 by the middle of this century.

In all probability, the under-45s can kiss goodbye to the prospect of receiving a state pension upon retirement, the provision of which could even be means-tested by 2035.

Almost 10 million UK workers have signed up for workplace pension schemes designed to supplement what is likely to be a very basic state pension. The government deserves credit for encouraging workers to save and for making such an enormous scheme compulsory. But will it be enough to avert an old age pension crisis? We can but hope.

For more financial advice, check out Peter Sharkey’s regular blog, The Week In Numbers.