What is the state of play regarding the UK state pension?

The last 24 hours have seen the issue of pensions come to the fore in the UK General Election debate. Much of this was triggered at Prime Ministers Questions yesterday.

Theresa May has refused to commit a Conservative government to retaining the “triple lock” on pensions during a boisterous final session of prime minister’s questions before the election. ( Financial Times).

For those unaware of what it actually means the FT helps out.

which increases the basic state pension by the highest of three indicators: consumer price inflation, average earnings growth or 2.5 per cent.

This policy has had consequences which I will look at in a moment and the Prime Minister did refer to one of them although care is needed with any number provided during an election campaign by a politician.

The prime minister also referred to the triple lock in the past tense, saying it “had” boosted incomes by £1,250.

She presumably means per year.

The cost of the Triple Lock

Back in September 2015 the Government’s Actuaries released a report stating this.

A hastily buried official report has estimated that the government is spending an extra £6bn a year protecting pensioners’ incomes and warns that the cost of doing so in future years could spiral further.

What this has done at a time of claimed austerity is to put pressure on the UK public finances.

The GAD report said the triple lock was already costing around £6bn a year, with £70bn in total spent on the state pension in 2015/16 — more than the combined education and Home Office budgets.

Also it had been in play at a time when real earnings growth has been weak which led to this.

The government report said that since 2010, the guarantee had meant that pensioners’ income was £10 a week higher than it would have been had their income been uprated by earnings alone.

So there had been a transfer from workers to pensioners. If we move to last November the Parliamentary Work and Pensions Committee updated us on the state of play. From the BBC.

As a result of triple-lock policy, the state pension has risen by a relatively generous £1,100 since 2010, with an increase of 2.9% in April this year.

The Committee concluded this.

However, MPs said that while pensioners had done well out of the triple-lock, young people and working-age families had suffered unfairly.

So-called Millennials, born between 1981 and 2000, face being the first generation in modern times to be financially worse off than their predecessors, they added.

MPs said the rising cost of the state pension – £98bn in the last tax year – was now unsustainable.

The Triple Lock has achieved its target

The rationale for the Triple Lock was explained by the BBC.

Historically, pensions were linked to inflation rather than earnings, which reduced pensioner incomes relative to those of the working population.

The economic objective was to bring them more into line and of course there was a political aim as part of this as pensioners are the group most likely to vote. But if we look at what happened next we saw a combination of circumstances and indeed a Black Swan event. Step forwards the Office for Budget Responsibility!

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014.

In this world pensioners would see incomes rise with average earnings and there would be no transfer from workers. We are of course reminded of my first rule of OBR club ( which is that the OBR is always wrong…) as the Work and Pensions Committee moves us from Ivory Tower fantasies to reality.

Low rates of earnings growth following the 2008–09 recession

This means that in reality the increases have been driven by consumer inflation and the 2.5% back stop more than earnings.

The BSP ( Basic State Pension ) was uprated in line with CPI in 2012–13 and 2014– 15, earnings growth in 2016–17 and the 2.5 per cent minimum in 2013–14 and 2015–16.

The Black Swan event was the drop in official consumer inflation to in essence 0% which impacted on the 2015/16 numbers which again brings us to the first rule of OBR club as of course it assumes 2% inflation until the end of time.

The irony of all this is that the original objective is in sight.

Provided the new state pension is maintained at this proportion of earnings the work of the triple lock, to secure a decent minimum income for people in retirement to underpin private saving, will have been achieved.

However there has been a cost to this.

Reform, a think tank, estimated that the triple lock will in 2016 result in annual state pension expenditure £4.5 billion higher than it would have been had a simple earnings link been in place. This gap can only grow.

The rising state pension age

One area that is awkward is the way that current pensioners benefit from the Triple Lock but future pensioners find that the system looks increasingly unaffordable and of course they have to wait longer to get theirs. Last Month Retirement Genius reported this.

John Cridland, the independent reviewer of the state pension age, made three key recommendations.

First, that the state pension age should rise from 67 to 68 by 2039, seven years earlier than currently timetabled…..The second report by the GAD presented a scenario of faster rises which could see those aged under 30 only having access to the state pension by the age of 70.

So there was potentially grim news for Millennials who seem only to get bad news don’t they?

Should we take it away from the well-off?

This suggestion has been floated in the Financial Times today.

The UK should not give a state pension to the rich and instead use the money to boost payments to the poor, the OECD has said. The Paris-based club of mostly rich nations said cutting payments to the wealthiest 5-10 per cent of retirees would “free up resources” to raise British pensions, which are low compared with other wealthy nations, for others.

An interesting idea and considering its readership group it is brave of the FT to print this! Whilst in itself it seems to have things in its favour (redistribution) there are catches. For example higher income groups will be paying income tax on this and sometimes at higher rates of it. Also there is the belief that this is a system that is paid into and we are excluding the group who in general will have paid the most. Of course reality is not like that as they paid in fact for their predecessors pensions but even so it is a little awkward.

Comment

There are various issues here. The first is the irony that the Triple Lock is under fire for in essence doing what it was aimed at which was pensioner poverty. It is not a cure but it has helped by raising the Basic State Pension. The catch has been the economic environment where low rises in real wages have combined with the choice of a 2.5% back stop to the increases have made it not only increasingly expensive but also the equivalent of throwing the Ring of Fire into Mount Doom to the forecasts of the OBR Ivory Tower.

So we have an issue of possible failure by success and if it has been that then it was the 2.5% back stop which has caused it combined with other choices such as limiting other benefit increases to 1% per annum. It is a complex mixture which looks unfair basically because it is.

We also live in a world where there are so many ch-ch-changes to state pension entitlement and whilst going forwards the state pension was raised a year ago there was a catch which resonates with me.

One of biggest changes to state pension in 2016 was scrapping of right for spouses to inherit partner’s pension when they died. ( Josephine Cumbo )

This is because when I sorted out my mother’s financial affairs after my father’s death she benefited from inheriting some of his state pension.

The establishment

They seem to be doing okay as this tweet about the retirement party for the Director of the Tate Gallery Sir Nicholas Serota suggests. The asterisks are mine.

Lots of Tate staff are outsourced, low-waged and/or on zero hours contracts. Tate are asking them to help buy Nick Serota a f**king yacht. ( @charlottor )

Me on Official Tip TV

http://tiptv.co.uk/housing-bubble-burst-boe-cut-rates-not-yes-man-economics/

What is happening to UK pension provision and schemes?

One of the features of the UK economic environment over the past decade or so has been the extraordinary changes in the rules and indeed position of pension provision. This covers both state and private-sector provision. Some of this has been related to developments in the credit crunch era but some is also related to pork barrel politics. What this has done is create something of a quagmire where benefits and losses are distributed often in a fairly random fashion which poses a problem. It was not that long ago I passed the advanced pension examinations of the Chartered Insurance Institute but the truth is that the landscape studied then no longer exists. This in itself poses a problem for an industry that exists for the long-term.

State Provision

There has been a dizzying array of changes here in recent years. Let me start with something which has had a positive impact on what many pensioners receive. From HM Parliament. BSP is the Basic State Pension.

The Coalition Government commenced the legislation and committed itself to increasing the BSP by a “triple guarantee” of earnings, prices or 2.5 per cent, whichever is highest, from April 2011.

That has boosted pension incomes and mostly via the law of unintended consequences. For example this year the uprating will be in essence a real terms increase as earnings were rising at 2.9% and official inflation has been very close to zero. This follows on from a 2.5% increase previously which means as I have discussed in my updates on the UK public finances that there has been quite an impact via higher expenditure which was estimated at £6 billion a year before the report was quickly redacted. Or to put it another way a type of generational shift in incomes.

As a result, someone on a full basic State Pension can expect to receive around £570 more a year in 2016-17 than if it had been uprated by average earnings since the start of the last Parliament,

This is not the whole story as confusingly what are called additional state pensions only have to rise with inflation and after the swerve a few years back to use the CPI (Consumer Prices Index) they are somewhat becalmed. So we have seen a change withing pensioners incomes as those who have paid in extra to get more have been treated less favourably than the basic pension. Just to add to the mix a new state pension starts in April for new pensioners and it will rise with earnings.

You will get it later

The UK state pension age has been 65 for a long time but it begin rising to 66 in December 2018 and 67 in 2026 in response to rising longevity. Later it will go to 68 but the rules will no doubt have changed by then as for example the change to 67 was brought forwards by 8 years in 2014! So far we have a familiar story of jam today where current pensioners have benefited but future ones face adverse changes although of course should the triple lock remain they will benefit too.

A catch in this saga is happening to a segment of the female population who expected their state pension at 60 and are now getting it at 63 on the way to it going to 65. This has become a contentious issue. Not so much on the issue of equality but much more on the lines of the fact that the changes were accelerated leaving one particular group disadvantaged as highlighted by the WASPI campaign and as I have pointed out earlier there is an issue with continual changes in something which relies on long-term planning. Also the pension age will be equalised at 65 just in time for it to become 66. Oh Well! As Fleetwood Mac put it.

The private-sector

If we look at the situation we see that the economic environment has changed substantially. There have been capital gains for some especially in government bond markets but looking forwards there is little yield now to be found in these areas. For example the plunge in yields has benefitted those who held both ordinary and index-linked UK Gilts. Those who have followed me from my beginnings will recall me making a case for holding index-linked Gilts. For once I was in concert with the Bank of England which put around 90% of its pension fund in them which has allowed it to fund the high level of pensions highlighted by what Mervyn King and the Deputy Governors have received. However looking forwards the picture is very different. For now there is a real yield but as soon as the oil price stops dropping it seems set to disappear and as pension planning is often over a 20/30 year timescale there is a problem.

As to changes well the Bank of England keeps promising but not delivering on higher interest-rates leading to the fear that like in Europe we could head lower. After all it was only last Thursday that the President of the ECB Mario Draghi hinted at a further cut to an interest-rate which is already -0.3%. Long-term contracts struggle with this sort of negativity as I recall when Andy Z placed the pensions illustration which has a return of -0.3% as part of it in the comments section. How does that work?

There is also the issue of equity markets where the capital to dividend position has been in reverse. We find ourselves in a situation where depending on the exact reading at the time the UK FTSE 100 has been on a road to nowhere this century overall whereas there have been dividend returns. If you want yield these days it has to be dependent on company profits such as utilities.

Legislation ch-ch-changes

The last decade or so has seen a litany of changes which returns us to the long-term planning theme. We have seen the minimum age for taking a private pension move from 50 to 55 but not a compensating move from 75 to 80. This is a bit bizarre as whilst there may not be a lot of people wanting to pay in at 75 why shouldn’t they be able to? Also there are complicated rules for continuing pensions beyond 75 but complicated rules invariably lead to trouble in the end – the law of unintended consequences again- as well as racking up a high level of fees and expenses. Plus rules have been set for maximum amounts both annual and lifetime with promises made and then welched on.

Now there has been this change which returns me to the switch between capital and interest of which the latter appears as annuities. From the BBC.

You can now access that pot freely from the age of 55 (57 from 2028), taking out as much as you like, subject to tax.

This is for defined contribution schemes where you pay in and receive tax relief and take the money later after hopefully it has grown and some 25% is then tax-free. The driving force behind this change is the poor value of annuities which has been driven by lower bond yields. Quite how they work now in Switzerland or Germany where many bond yields are negative I do not know? But whilst annuities are flawed they do guarantee an income as we wonder what happens next.

So such a change should encourage more pension provision but the many changes are likely to have a reverse effect as people wonder if it will last? The uncertainty is added to by the proposal to scrap higher-rate income tax relief. This has been trimmed to some by other changes and has equity and fairness on its side to some extent but would be yet another change in a very long list.

Defined benefit schemes

This has been perhaps the clearest shift of all as it dies away in the private-sector and only exists in the public-sector because the full costs are rarely looked at. Also of course ministers, MPs and high level civil servants are the current major beneficiaries of them! But with inflation indexing so expensive in spite of the current low inflation rate there is trouble. The problems for the private-sector are added to by the rules under which they operate for solvency and assessment which are somewhere between bizarre and crackpot in my opinion.

Those retiring now on such schemes are benefiting highly and apart from the public-sector schemes that is now mostly in the past. A famous beneficiary was former Bank of England Governor Mervyn King whose antipathy to RPI inflation did not extend to his own pension fund which ended up being worth around £8 million. Of course on the other side of the ledger the case is much muddier for nurses,teachers and the police who get much lower sums and would reasonably argue that it is part of their pay deal.

Comment

There are good news stories here as it used to be the case that UK state pension provision was low and had been left behind by events. Obviously there are still people with low incomes but the rise in the basic state pension will have particularly helped the less well off and I welcome that. Although it has resulted in another issue for the public finances

But the multitude of other changes that have gone on have created an atmosphere of mistrust and who could blame the young for having no confidence in what they will receive? They could lose out at a stroke of a bureaucrats pen. The continual Ch-ch-changes are likely to see yet more money head towards the housing market where the situation is much simpler and easier to understand than pensions. This from the Guardian suggests changes in that direction.

A record amount of housing wealth was unlocked by homeowners aged 55 and over in 2015, with £1.61bn withdrawn through specialist equity release plans.