By Alan McFarlane
OUR retirement savings and pension systems face unprecedented pressures.
Today’s western societies operate pension systems for lives of three score years and ten and populations with lots of young people and few retirees.
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Those assumptions no longer apply. Indeed, we’re not even sure when workers in their 20s, 30s, or even 40s can expect to retire or if they will do so at all.
Much of the UK’s problems are because the state pension system is unfunded. What’s called our “National Insurance Premium” doesn’t create a fund with our names on it. The National Insurance Fund works on a pay-as-you-go basis. Today’s contributions pay today’s benefit recipients. So politicians can move the goal-posts at any time.
The system needs a major overhaul designed to give people a clear link between their contributions and their ultimate pension. Reform Scotland’s proposal is a Universal Contributory Pension (UCP). All workers should save into a defined contribution pension to pay for their old age. And we argue that it could – and should – operate independent of the state.
We argue that workers should pay a mandatory minimum percentage of salary, starting at eight per cent, into a defined contribution pension scheme of their choice.
The state’s role should focus on regulation and promotion. To catch those in need in later years there should be a means tested, minimum guaranteed old age income, currently provided through the Pension Credit.
Take an appropriately long view, 40 years plus, and the state pension could be phased out gradually while covering those who have contributed National Insurance in the past. People would pay into pension funds of their choice, ideally supported by tax incentives. The trade-off for the Government is simple; incentivise savings today to reduce expenditure later. Each person would know how much was in their pension account and how that pension was managed. People could invest in the things that mattered to them, whether renewable energy or companies with better corporate governance. This has the potential for the democratisation of capitalism.
Pension pots would be fully transferable, making job shifts easier.
One of the UK’s looming problems is the sharp divide between a public sector with defined benefit pensions and a private sector without them.
In the long run there needs to be new thinking about how people draw on their pension savings while continuing to work. Lots of us will want “worktirements”, made much easier by personal control over our pension savings Perhaps most importantly, this puts a buffer between the individual and the state.
Such a scheme would also relieve the burden placed on the next generation as each generation would provide for their own retirement.
All pension contributions under the UCP would receive a flat rate of tax relief from the Government irrespective of the amount and rate of tax paid by the beneficiary.
As employees would be paying into their own pension pot, we believe that employees’ National Insurance of 12 per cent of salary should be scrapped, and instead 7p added on to each rate of income tax initially to balance the cost of scrapping NI. However, over time the additional tax could be reduced as the burden of the current state pension falls away. Employers’ National Insurance would be retained and renamed as a payroll tax. We would also increase the personal allowance to £12,000. This would ensure those on the lowest incomes were better off and not disadvantaged by the introduction of the mandatory contribution.
Reform Scotland’s proposals address the problems of the 20th-century pension system which is no longer fit for purpose. Successive governments tinker with the pension rules but a new system, built for our future challenges, needs to be built. The UCP will take power away from politicians and give it to people and free the next generation of the burden which our pensions system places upon them.
Alan McFarlane is chairman of Reform Scotland.