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How to get pensions working again

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  • How to get pensions working again


    Britain's generation gap in retirement savings is a ticking timebomb. But what is the solution?


    Phillip Inman will be live online from 12.30pm today. Post your questions here
    The government should force older workers to delay retirement or accept lower occupational pension incomes to close a growing rift between the generations and help lead the economy out of the recession, according to two former government advisers.
    Alan Pickering, a former independent Treasury adviser, and Ros Altmann, a former adviser to Number 10, fear the demands of affluent pension savers will rapidly become a massive drain on the exchequer, threaten the survival of many businesses and damage the prospects of younger workers.
    They say people over the age of 50 in final salary pension schemes must take a cut in income of at least 10% or work longer as a gesture to younger workers, many of whom could be forced into poverty to pay for guaranteed retirement schemes.
    Without significant pension reforms and other key shifts in government policy, Pickering said Britain would emerge from the crisis with unsustainable retirement promises to a privileged group of public and private sector workers, which would act like a tax on younger generations.
    Altmann said the government needed to "redraw the pensions landscape" to avoid creating a wider gap between haves and have-nots in retirement than already exists among people of working age.
    Steeply rising pension costs are an issue for most governments in the developed world, where postwar promises to the baby boomers have become unaffordable.
    Increasing life expectancy and poor investment returns have pushed up the cost of retirement. Baby boomers, as the name suggests, will swell the numbers of retired people between now and 2040.
    In the UK alone, private sector pensions are more than £200bn in deficit, while the shortfall in guaranteed pension promises to public sector workers has topped £1tn.
    The system in the UK is unique in Europe and would need its own set of remedies. Five options that could begin to bring about a more equitable and sustainable situation are outlined below:
    Option 1

    Raise income tax. Until a couple of years ago, it was Liberal Democrat policy to tax earnings above £100,000 at 50%. This policy could be resurrected. Another band at £70,000 would levy a 45% rate. Together with the crackdown on tax havens expected to be agreed at the G20 summit, a rise in income tax would stifle the bonus culture and help address growing income inequality.
    VAT - a regressive tax prone to fraud - could also be maintained at its new lower level of 15%. All the major political parties have resisted such proposals, believing them to be electorally damaging, but with the government running out of funds, it will need to look again at raising tax, especially for the more affluent.
    Option 2

    Tax on land or property. House price gains are not taxed, which means housing has a tax advantage over other types of assets, even after stamp duty and inheritance tax were taken into account. In 2006, at the height of the last boom, inheritance tax and stamp duty raised £8bn, just 2% of the £340bn gain in house prices.
    Property has become a key savings vehicle for many people, who expect to use buy-to-let flats or their main residence to generate a pension income. A land value tax could be the best way to forestall a much predicted return to sharply rising property prices in 2011. A tax would drain 1-2% from the total value of land each year, encouraging land owners to be more productive. Combined with stricter lending rules on banks, this could end the British obsession with generating "magic" profits from dealing in land and property.
    A land tax could replace capital gains tax and inheritance tax. Depending on the rate, it could also be used to abolish council tax and reduce corporation tax.
    Option 3

    Focus on younger workers. David Blanchflower, the influential economist and member of the Bank of England's monetary policy committee, who predicted the recession, said the government should undertake "a substantial fiscal stimulus focused on jobs as soon as possible".
    Large cuts in national insurance contributions targeted at the low-paid and the young would be coupled with encouraging the under-25s to be in education rather than becoming unemployed. To prevent long-term unemployment, Blanchflower backs those who propose a job guarantee scheme after 12 months' unemployment for 18 to 25-year-olds and, after 18 months, for 25-plus.
    Blanchflower argues we will all be worse off if we let unemployment soar, thinking it is someone else's problem.
    Option 4

    Scale back pension commitments. An immediate cut in pension commitments by employers could allow manufacturers that have maintained final salary plans to weather the credit crisis and save jobs.
    Final salary schemes disproportionately reward staff who retire on large salaries as they are linked to pay immediately before retirement. Public sector workers, especially those on higher salaries, should also have their commitments reduced to fit the new economic environment.
    More radically, pension payouts could be held to a maximum of £28,000 a year. This would be combined with the 10% cut and would be seen as a much more direct attack on the retirement living standards of senior managers in the private sector, Whitehall and the broader public sector.
    Combined with a state pension, it would mean workers could aspire to a retirement income of almost £33,000 a year from tax-free pension savings. The average private pension generates between £1,500 and £2,000 a year. The average local government pension is about £4,200. Obviously higher paid workers could save out of taxed income for their retirement.
    Option 5

    Scrap pension subsidies, especially tax relief on contributions for higher rate taxpayers. About £30bn a year is spent subsidising pension contributions through tax breaks. Contributions are paid out of gross income, which means higher rate taxpayers avoid paying 40p in the £1. More than half the subsidy is spent on higher rate taxpayers.
    The move could be combined with scrapping the government's planned occupational scheme "for all". The Department of Work and Pensions has issued tenders to private sector suppliers for its new scheme of personal accounts. The pension plan, designed in 2006 by Lord Adair Turner, the new City regulator, is due to sweep up the 8 million low-income workers not in an occupational pension.
    Critics of the scheme argue it will prove complex and costly with a price tag on the system of between £500m and £1bn. It is also flawed because hundreds of thousands of workers will save in the scheme only to miss out on means-tested benefits when they retire.
    • Tomorrow: How do we end the banking crisis?



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